Negative prices show a global oil market under unprecedented strain

Why would any commercial company sell its product at negative prices?

The May futures contract for West Texas Intermediate, the main US crude grade, opened yesterday at $18.27 but closed at minus $37.63 per barrel.

The reason – a game of pass-the-parcel with oil that no one wants.

WTI’s plunge broke all kinds of records: a one-day drop of 306 per cent, and a close some way below the historic low of positive $10.42 per barrel in March 1983.

It’s a sign of the current market chaos that we now have to specify when we’re talking about positive oil prices.

Physical commodities can reach negative prices when there is no market for them, but the producer is compelled for some reason to continue output.

Electricity prices frequently go negative because renewable energy such as solar and wind, with zero operating costs, sometimes exceeds demand, but shutting down coal or nuclear power plants for brief periods is costly or practically unfeasible.

Natural gas prices in Texas have at times gone negative because pipeline capacity is insufficient, while the gas is a by-product of oil output. Producers wanted the oil and had to accept a loss on the gas.

WTI is one of the three main grades used for worldwide pricing, along with Brent from the UK North Sea, and Dubai/Oman.

Futures contracts for these crudes are traded on transparent, regulated, highly liquid exchanges for several years ahead, allowing oil producers, physical traders, refiners and others to lock in prices or buy or sell options to manage their risks.

The WTI contract for each coming month expires around the 20th day of the present month, varying slightly depending on weekends and holidays.

Paper traders have to close out their position by this point or take physical delivery of crude, something that most financial players neither want nor are capable of doing. Usually, this presents no problems.

But the world oil system is under unprecedented strain because of the collapse in demand due to the coronavirus pandemic, combined with the price war between Saudi Arabia and Russia.

Even though the Opec+ countries patched up a new deal a week ago, tankers are already on the water.

The effect of production cuts will not be felt until May at the earliest.

Even then, about 7.4 million barrels per day of output cuts on February levels are not enough to stop a market collapse when they collide with as much as 30 million barrels per day of lost consumption this month.

There was ample warning of the WTI collapse. Some onshore North American crudes have gone to very low, even negative prices for physical delivery in recent days.

Western Canadian Select, the main Canadian heavy grade, also turned negative on Monday.

Inland refiners in North America are cutting runs because they have neither a local market nor a route for export.

At contract expiry, the physical and paper prices should converge. In this case, someone was left holding the parcel.

Storage at Cushing in Oklahoma, the main US tank hub and the delivery point for WTI, is filling but not entirely full, with 55 out of 76 million barrels working capacity being used. But all remaining space is probably already reserved.

Why don’t producers simply close in their wells? They may have contractual obligations for delivery or pipeline transport.

Shutting down fields safely also costs something. And marginal wells, once halted, may never be commercial to restart, therefore producers hang on for a few months of losses, hoping prices will recover.

Of course in this game of chicken, the onrushing truck eventually hits someone.

The June WTI contract closed at $21.03 per barrel, almost $60 per barrel above its sibling, which is a massive profit for anyone with access to storage.

Yet the same price collapse will happen again at the expiry of the June contract next month, unless demand rebounds very sharply, output collapses, the government enforces production cuts, or there is an unexpected discovery of additional storage space.

The US government has been scrambling to find funds to buy oil for its Strategic Petroleum Reserve, which has about 77 million barrels of space available. Now, it could make a profit filling it.

Brent was not nearly as affected as WTI. It dropped $2.21 on the day to close at $25.87 per barrel.

This is because it is a seaborne crude that can be loaded on tankers, stored if necessary, then sold to whichever market is willing to take it.

The May contract for Brent has already expired, while June expires on April 30.

Negative – even very negative – prices do not directly harm oil companies or Middle East exporters. It is for now a matter for local and landlocked producers.

But it is a warning sign that low, even very low, prices are on their way globally, a necessary and bitter medicine to bring the market back into balance.

Robin M. Mills is CEO of Qamar Energy, and author of The Myth of the Oil Crisis