Negative Prices Come to the Oil Market

Well, now I’ve seen everything. I warned not long ago that the oil market was in for more pain. But I wasn’t expecting to see oil prices actually turn negative, which they did on Monday.

Granted, it was only the May futures contract for West Texas Intermediate that managed to trade below $0. WTI futures for delivery in later months managed to stay in positive territory. As did Brent, the crude benchmark most cited outside of the U.S.

Still, sellers paying borrowers to take their oil is not something we’re supposed to see. After all, it costs money to pump oil out of the ground. And it’s hard to think of a commodity more critical to our modern, industrial society.

But there it was: -$40.32 per barrel at one point in Monday trading. What the heck happened, and what comes next for oil?

Basically, traders drove WTI into negative territory out of fear that there would be no place to store oil scheduled for May delivery in Cushing, Okla., where the contract is physically settled. The coronavirus pandemic has slashed global oil demand by somewhere around 30%, but production remains near its normal level. All that surplus crude needs somewhere to go, and the world’s storage tanks and oceangoing oil tankers are filling up fast. Paying to avoid having to take delivery of unwanted oil briefly made financial sense in some cases.

Normality has since returned to the market, with June WTI futures trading near $17 per barrel: Still cheap, but at least above $0. (It’s hard to believe that, as recently as January, WTI was at $63. The current price is lower than what was seen at any time during the Great Recession of 2008-09.)

Can prices go lower still? I think so.

Think of the current oil market as a race between producers trying to curb output, and the remaining oil storage facilities, which are getting close to full. Can producers cut fast enough to avoid having literally no place for surplus crude to go?

OPEC and its allies have agreed to cut their combined exports by nearly 10 million barrels of oil per day starting in May. In normal times, that would be a massive decrease. But world oil demand, normally close to 100 million barrels per day, is probably closer to 70 million now because of the hit to global travel and economic activity. So even OPEC’s cuts leave plenty of extra oil. Meanwhile, U.S. output has started to fall, but so far, only by a small amount. Bigger cuts somewhere, by someone, are needed to keep crude stockpiles from growing further and potentially spilling over.

Oil demand should start to recover once the worst of the public health crisis is past. But how soon will that be? Soon enough to start soaking up all those extra barrels of oil? And even as energy companies shut down drilling rigs or cap existing wells, can supply fall fast enough to match anemic demand?

It’s an open question. But the fact that it even has to be asked means that oil markets will stay extremely volatile. If production continues to vastly exceed demand for another couple of weeks, the glut will get considerably worse. And traders will find themselves in the same position they were in this week: Nervous about owning the rights to a commodity they can’t sell or store. Prices may not go negative again, but don’t be surprised if they flirt with $10 per barrel before the worst is over.

Perversely, weak demand and low prices today could lead to a price spike at some point later, when world oil demand recovers. Capped wells can be difficult to restart. New wells that would have been drilled and meeting future oil demand aren’t getting drilled now. OPEC may be reluctant to quickly resume normal exports as prices rise.

Basically, the only constant you can count on in this oil market is rapid change.