What do negative oil prices tell us?

by Shaun Richards

Yesterday brought a new development in the word of negativity. We regularly look at negative interest-rates and bond yields here and a couple of years ago or so noted negative prices for gas in the Permian Basin.More recently we have had to come to terms with negative economic growth rates. But then there was something new to see. From the BBC.

The price of US oil has turned negative for the first time in history.

That means oil producers are paying buyers to take the commodity off their hands over fears that storage capacity could run out in May.

Demand for oil has all but dried up as lockdowns across the world have kept people inside.

As a result, oil firms have resorted to renting tankers to store the surplus supply and that has forced the price of US oil into negative territory.

The price of a barrel of West Texas Intermediate (WTI), the benchmark for US oil, fell as low as minus $37.63 a barrel.

What has happened here?

The BBC does get some bits right bit also some wrong so let us start with the correct bits. The oil price has been under pressure due to lower demand as the tweet below highlights.

Coronavirus has wiped out more than 90% of international flights ( @ZSchneeweiss )

Some were pointing out that they had filled up their cars ahead of the lockdowns only not to drive anywhere giving us a form of storage for these times which is in car petrol or diesel tanks! But the crucial point was that in most cases ( like me) they have not driven anywhere. I am sure you can think of other examples.

Missing from the BBC piece is that in a type of turf war Saudi Arabia and Russia decided to sing along with Elvis Costello on the 8th of March.

Pump it up, until you can feel it
Pump it up, when you don’t really need it

I still remember the shock of that Sunday night into Monday morning when the oil price fell to US $30. It seemed a big deal at the time and was but the increased supply in an example of hubris or accident or both flooded into a collapse in demand.

There is another factor in play so let us return to the BBC on the 12th of this month.

The initial details of the deal, outlined by Opec+ on Thursday, would have seen the group and its allies cutting 10 million barrels a day or 10% of global supply from 1 May.

This U-Turn was trumpeted at the time by the BBC who rather curiously were for once in concert with The Donald.

The big Oil Deal with OPEC Plus is done. This will save hundreds of thousands of energy jobs in the United States. I would like to thank and congratulate President Putin of Russia and King Salman of Saudi Arabia. I just spoke to them from the Oval Office. Great deal for all!

How wrong can you be?

The next factor is that the cuts do not start until May 1st and that matters because the May future ends this week. Many futures contracts are like that and wither expire in the month before or roll over to a later month in the month before. So May is April and confusingly expires before the output cuts in er May. Please do not shoot the messenger.

Next returning to the original BBC article they have made a mistake.

As a result, oil firms have resorted to renting tankers to store the surplus supply

The problem with WTI is that it is a land locked contract and so they cannot do that. By contrast Brent is a sea bourne contract and thus is being stored in oil tankers which are available for obvious reasons. Here is shipbrief.com from a few days ago.

As of April 16, data provided by VesselsValue shows that of the 802 VLCCs on the water 60 are now being used as floating storage. Suexmaxes come in at 37 of the 566 live vessels while crude Aframaxes number 35 out of 694.

So Brent Crude dodged a bullet for now anyway because there is somewhere to store it whereas there are obvious issues for landlocked contracts in using supertankers.

So pressure came on the WTI contract and specifically the May one as it expires before the output cuts and there is another issue tucked away in its definition.

Deliverable

You have to take some of the black stuff whereas for Brent you can simply settle in cash. So as the May WTI contract came to its end it found a lot of people long oil suddenly facing up to the fact that they were being squeezed and even worse that anyone they might try to deal with knew it. Thus the price fell. Then it got added to by volumes being low and I am sure that meant that some gave it a nudge or “low ticked” it.

Let me explain that. If you have a large position say short 50,000 oil futures and you can move a price by selling 10 then you might be willing to sell that 10 for -$10. In itself it is crazy but should the price of the 50,000 move only marginally you can sing along with Hot Chocolate.

So you win again, you win again

Have I seen people do this? Yes.

As you can see there were quite a lot of factors in play and context is needed because the June futures contract was at US $22 or so and trading actively all day. There were also elements of confusion because it turned out there were some places you could store some WTI crude so perhaps in the panic some brains got a little frazzled.In fact it became such a mess I could see some of the trades being busted. The main factor against that is that it would be very embarrassing so probably will not happen.

Comment

Let me point out a consequence I tweeted yesterday.

The contango in the oil price may trade like an option. It will be interesting to see if the June future ( $22.84) is pulled down to the spot price ( $11) or whether there will be more of a merger over the next month…

I was already thinking that the June WTI would get that sinking feeling as May faded from view. That was based on two factors. Firstly valuing the gap between it and spot as an option and secondly thinking of spot being an anchor it will be pulled down too. With the June WTI future at US $12.82 as I type this we see yet another example of financial life being on speed.

If we now look at the economic consequences I am one of the few who welcome lower oil prices and their impact on inflation. This will help workers and consumers in terms of real wages in what are going to be hard times. There are a couple of nuances to this. Let me start with the fact that as we are using less of it the gains are reduced. The second is that there is also a switch from producers to consumers as oil producers will be hit hard. In fact there is an irony here because this is one of the causes of where we are which is the Saudi/Russian attempt  to get the oil price below the break even for US shale oil wildcatters.

Next comes a consequence via financial markets which is that some funds and banks must be in trouble from this. Before this latest phase we were seeing stories like this.

SINGAPORE (Reuters) – Singapore oil trader Hin Leong Trading (Pte) Ltd, which has begun talks with lenders to extend its credit facilities, owes $3.85 billion to 23 banks, two industry sources said on Thursday.

Now will be worse with the only saving grace being that volumes were low. Of course that may yet change with the June future falling today.

What is next? Perhaps we could see QE for oil from the US Federal Reserve…..

Let me finish with some humour from The Guardian back in December 2013.

A former British Petroleum (BP) geologist has warned that the age of cheap oil is long gone, bringing with it the danger of “continuous recession” and increased risk of conflict and hunger.