Market Brief - April 24, 2020

Erica Szczech - Apr 24, 2020
As COVID slows down and markets stabilize the real history-making news this week comes from WTI May oil contracts closing negatively for the first time ever.
Oil Pump in sunset glow

Lots of news over the past couple weeks, with COVID slowing down in some countries and North American markets stabilizing. The real history-making news happened on Monday this week, when the WTI (oil) May futures contracts were allowed to trade negatively, or below $0 for the first time in history.

How this happened, on Monday the May contract or the front month (which is the price you see reported in the market), was due to expire at 2:00PM on Tuesday. The exchange allowed the contacts to trade negative, and oil fell over $50 per barrel or down 275.9% overall, trading as low as -$37 per barrel before recovering to close at -$24 per barrel. To understand this phenomenon, let’s consider the underlying situation with oil.

As we wrote about previously, after OPEC+ agreed to lower production by just under 10M barrels per day with a May 1st start date, it became apparent that even this reduction in output would not be enough to help push prices higher considering the over-supply which currently exists. Some experts predicted OPEC+ would need to cut by more than 30M barrels per day to be effective, not withstanding the storage issues.

So why did oil trade negative?

Oil trades on a futures basis with contracts expiring and delivery taking place as these contracts expire. The market always looks out 6 – 9 months, which currently indicates a price recovery later this Fall. But on Monday, before the May contracts were set to expire and the June contracts commenced, physical delivery needed to take place. This means anyone left holding the May contracts at the close on Tuesday would have to go to Cushing Oklahoma, and physically take delivery of their oil. If you were not able to do that, then you needed to find a buyer for your May contracts – hence going so far as to ‘pay someone’ (or negative rate) to take your May contract.

Then, there was the storage issue - even though there might have been extreme value in buying oil at next to nothing, or getting paid to take it, there simply is no where to put it. Or if you have space for it now, that space is generally already contracted out and spoken for in a future month.

US firms are looking for storage options, including building new facilities and considering temporarily storing crude in railcars and storage wells. Building new tanks at Cushing Oklahoma can take up to three months, even after permitting is complete. There is already an increase globally of oil tankers waiting offshore to unload.

We expect this oil pricing pain to last through April to May, while weak global demand and the highest amounts of inventory are in place. Once demand starts to pick up and lockdowns are lifted, the over-supply will be alleviated – but will we ever go back to using as much oil as we did pre-COVID? Perhaps not.

 

We'll keep you updated on the oil sector as events unfold. If you have any questions, give us a call.