Marius Paun | London, UK | Senior dealer | Tuesday, 21st April 2020
Yes, you read it right, US oil prices dropped below zero for the first time ever. The US Oil May contract (aka West Texas Intermediate) tanked more than 100 % and settled at a mind-boggling price of negative $37.63 per barrel. Shocking as it may sound you can get negative oil prices in extraordinary situations as we are experiencing now. Simply put, this means suppliers will need to pay buyers to take delivery of crude oil. It is also indicative of a growing glut in crude supplies and a lack of storage space.
However, part of the steep fall can be explained on a market technicality. The oil futures contracts, or any commodities futures for that matter, have predetermined delivery dates. On expiry, these futures contracts demand delivery of the underlying product. So as we get near to the contract’s expiry date, the price of that oil futures contract converges with the physical price of oil. In effect the buyers of those contract i.e. oil refineries, airlines etc take delivery of physical oil.
The timing of those deliveries will match the timing of their specific needs, for example, the peak of the travel season may convince airlines to take more delivery of summer months contracts. That’s very simplistic but you get the point. But players in the oil market are not just those who use the commodity itself. Speculators on oil futures far outnumber physical buyers looking to hedge their underlying peaks and troughs in demand for the oil.
Near the contract expiry, those speculators will start buying next month and conversely selling (to close) the existing contract. Thus, the downside move in US Crude May price was accelerated by traders who had bought oil previously, at what they believed to be at these cheap levels, then looking to sell out of their positions in the May contract, only to reopen a position in the June contract, a process called a rollover. And indeed, the US crude May contract was close to its delivery date. As a matter of fact, there were widespread headlines saying that ‘a lack of storing capacity at Cushing, Oklahoma (main delivery point for the US crude) has spurred traders to offload positions rather than take on physical oil without any space to put it’.
In comparison, the US crude oil contracts for later deliveries i.e. WTI June contract dropped ‘only’ 16% to $21.09 per barrel while July contract slipped less than 7%. So, looking for some better news, it was somewhat encouraging (so far?) that this strange phenomenon did not happen with similar intensity across the oil curve (reflected by all these deliveries going further away in time). WTI June and subsequent deliveries have remained above $20 per barrel.
The important question going forward is could this happen again i.e. going to below zero, for WTI June contract (and the rest)? Analysts at Citi have already warned that Brent crude could follow WTI crude and slump to zero if the global storage picture gets even worse. What makes the situation even more tricky is that in the real-life, shutting down an oil well to stop production is not that easy. First, it costs money and more importantly there is a risk the oil well could be damaged permanently, by taking such action.
The International Energy Agency warned that demand in April could be 29 million barrels per day lower than a year ago. So, we have a significant slump in demand versus a supply-side which looks to be a lot more inelastic. It is easy to see why oil storage availability has become so important.
Due to the current global oversupply in crude oil, giant tankers are now storing a record 160 million barrels, Reuters reports. As conventional oil storage facilities have almost filled up, the ‘super-tankers’ have become high in demand, holding up to 2 million barrels of oil. This so-called floating storage is now close to levels last seen in 2009 when more than 100 million barrels were stored at sea. These giant vessels have seen charter rates doubling in the last month to reach highs of $350,000 a day!
Reuters also reported that shipping experts are saying 60 super-tankers have been chartered to store oil, mainly in the US gulf coast and off the coast of Singapore. That number rose from between 25-40 at the start of April. It is expected that in the coming months up to 200 super-tankers could be used as floating oil storage.
The chart above is a continuation chart. Yesterday’s low of -$40.32 was done in WTI May but now we have moved to WTI June which at the time of writing is around $14 per barrel.
The sellers are firmly in control indicated by just about every indicator. Short term moving averages are below the longer-term ones, all pointing downwards, price is well below the moving averages. It also shows a string of lower highs and lower lows since oil touched its peak of $147.27 on 1st of July 2008. In hindsight that seems almost surreal now.
On the downside, -$40 per barrel was never seen before. Could we retest that level, or at least zero, again in the near future? It would take guts to fully discard it. On the upside the next target level would be just above $19 which acted as good support in 2002 and has now become resistance. If they are successful in breaking above that, the buyers will look to $25.67 followed by $33.52, the support of early 2016 and 2009 respectively.