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Oil Goes Below Zero: What's Behind the Negative Pricing?

Nilanjan Choudhury
·6 mins read

Just how low can oil prices go? Every day seems to be worse for the commodity as it sinks lower and lower into the teens. And just Friday WTI crude futures fell below $18 a barrel at one point – the lowest in two decades. But is it possible for oil prices to go negative? Yes, let’s see how and why.

Oil Prices into Negative Territory

In a bizarre turn of events, oil futures took a dive on Monday and it was, well, worth less than nothing. On the NYMEX, May WTI crude - the price of a contract to deliver WTI oil next month - which expires at today’s settlement, fell $55.90, or 306%, to finish at -$37.63 a barrel. That was the lowest ever settlement for a front-month contract and the largest one-day drop on record. The emergence of sub-zero price simply implies that sellers now have to pay buyers to take their oil.

How Can Crude Settle Below Zero?

The nearest-month oil contract is suffering from a perfect storm of bad news – demand slump, the global coronavirus pandemic and a supply glut. Understandably, most of the blame rests with WTI going into a precipitous free fall. And more importantly, the lack of significant storage capacity amid the growing glut further puts pressure on prices. In other words, the collapsing May contract indicates that traders and speculators are desperate to liquidate their contracts at whatever realization they could fetch. This way, they would at least avoid taking physical delivery of the commodity with no place to put it.

Traders Rush to Offload Positions

In the energy markets, oil futures are basically contracts or agreements to buy and sell a specific amount of the commodity (in physical form) at a given time in the future. This is a kind of financial instrument that determines the price of oil. Until recently, the WTI contract for May delivery was the most efficient way to trade oil and a reflection of the current price. However, the contract is set to expire today and the seller must deliver the oil to the buyer at a pipeline or storage facility. This is where things are getting tricky in the prevailing environment. With the traditional inland storage facilities to store oil running out, traders are scrambling to sell their contract before having to physically acquire the oil and keep it, starting next month. On the other hand, whoever agrees to buy the contract now will have to take physical delivery of thousands of barrels of oil and put it somewhere.

Storage Crisis 

That’s a nightmarish prospect right now. With no place to put the crude amid the coronavirus-forced demand destruction and collapse in prices, no one wants to take delivery. Per the latest figures from the EIA, the oil storage tanks at the Cushing terminal in Oklahoma (the key delivery hub for U.S. crude futures traded on the New York Mercantile Exchange) are around 70% full. This has prompted traders to buy giant tankers as floating storage, allowing them to move the (cheap) commodity onto ships and wait for an eventual recovery in prices. In fact, increase in demand for such vessels over the past few days have led to surging rates for offshore oil tankers.

What Does Sub-Zero Oil Imply?

The massive plunge in the May contract doesn’t imply that all oil producers will have to pay buyers $37.63 for every barrel of crude they churn out. It just means that market participants who bet their exposure on the price of oil will be forced to shell out money to free them from a contract they don’t want to honor. Meanwhile, June crude, which will now become the front-month contract, changed hands at $20.03 a barrel yesterday. The fact that prices for later delivery are trading at a massive premium to those for immediate dispatch indicate a state of ‘contango’. Analysts consider this as a bearish signal with the so-called contango market leading to stockpiling by increasing the incentive to put oil in storage for later sale.

Oil Market Imbalance Set to Continue

The news of unprecedented negative futures contract comes on the heels of a 20% slump in WTI prices last week. The crude benchmark crashed to its lowest level in two decades as concerns about the coronavirus-induced demand destruction continue to outweigh the historic OPEC+ deal to curb production.

Independent energy research and business intelligence company Rystad Energy estimates a massive supply surplus of 27.4 million barrels per day in April, while The International Energy Agency (IEA) projects the imbalance for the month at 29 million barrels a day.

This implies that oil prices are unlikely to trade much higher from current levels. It's been a catastrophic year so far for crude oil, with the American benchmark WTI suffering a dramatic collapse. Even the likes of ExxonMobil XOM, Chevron CVX, Royal Dutch Shell RDS.A and BP plc BP are struggling to contend with these low commodity prices with their dividend paying business models under severe pressure. But some E&P operators like Occidental OXY — carrying a Zacks Rank #3 (Hold) — had to slash their dividend payout.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Yet, expect more pain ahead. The continuously falling global consumption on account of the coronavirus pandemic will further delay the market’s rebalancing. As the world remains awash in crude oil, prices might go even lower before they start climbing higher.

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