WTI crude prices went into negative territory last night. In today's article we discuss why.
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Last night the price of a WTI contract (the May contract) went negative for the first time in history. The same contract that cost nearly 20 dollars on Friday was briefly available for -40 dollars. Yes, this does literally mean that you would have been paid 40 dollars to take crude off a supplier’s hands. We’ve touched on the role oil has played in this Covid-19 crisis previously, but now is a good time to delve into the detail a bit more.
Why is this oil move important? Well, it demonstrates quite clearly that the oil market is currently broken. We have discussed various dislocations and anomalies in the market for months, this oil move is just a very explicit example of one of these dislocations. Over the last few months we’ve seen many other (mostly temporary) market glitches ranging from erratic currency moves to liquidity issues in treasury markets. We are seeing the result of what happens when you superimpose mass speculation onto an environment of unprecedented global stimulus.
Let’s rewind a couple of months and clarify exactly how we got to this point. The world’s major oil producers manage the price of oil through OPEC. At the start of this crisis, OPEC tried to agree on oil production cuts between it’s various members in order to stabilise the oil price, given the huge slump in expected demand. Saudi Arabia was only willing to play ball provided Russia (not in OPEC, but in the OPEC+) would match these cuts. Long story short, Russia and Saudi Arabia had a little spat, Russia refused any production cuts, and the cartel was in disarray. The killer blow came shortly after, when Saudia Arabia upped the stakes and threw fuel onto the fire by announcing production increases. This turned out to be the catalyst that started the most rapid general market sell-off in history. Saudia Arabia essentially added supply-side shocks to existing demand side-shocks. Not only did the world now have less demand for oil, additionally the world had too much oil inventory almost overnight. Of course there was a political angle to this move. Saudia Arabia and Russia can withstand the lowest oil prices by far. Lower oil prices would ultimately flush out weaker competitors and increase their own market shares. Specifically some believe this move was aimed at the US shale industry which relies on much higher levels.
Fast forward to today: We’ve had months of low oil demand coupled with excess supply. Initially customers bought up oil at cheaper levels (some customers considered these prices the bargain of a lifetime). However, we soon ran into storage and capacity issues. Oil isn’t something you can just keep in your garage – in order to take physical delivery you need capacity, and storage costs are not negligible. Inventory levels are now so high (in a nutshell because we stopped flying and driving months ago) that there is no literally no place to put it.
And now onto specifically what happened last night: The May contract for WTI Crude oil temporarily collapsed and went as low as -40 dollars a barrel. This was a temporary state, as the same contract is now back in positive territory. Why did it happen? Simply put because there is SO little demand for oil right now, SO much supply and far to many speculative players (this is exacerbated by ETF activity). Essentially it means that currently nobody actually wants to take physical delivery of oil, and everyone is relying on hopefully being able to roll their contracts. What is the takeaway here? Don’t assume that ANY asset cannot possibly trade lower in an environment as stressed as we are currently in. Market anomalies are still present, and occasionally stimulus bandages fail to cover them up.
What’s up with oil?
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Last night the price of a WTI contract (the May contract) went negative for the first time in history. The same contract that cost nearly 20 dollars on Friday was briefly available for -40 dollars. Yes, this does literally mean that you would have been paid 40 dollars to take crude off a supplier’s hands. We’ve touched on the role oil has played in this Covid-19 crisis previously, but now is a good time to delve into the detail a bit more.
Why is this oil move important? Well, it demonstrates quite clearly that the oil market is currently broken. We have discussed various dislocations and anomalies in the market for months, this oil move is just a very explicit example of one of these dislocations. Over the last few months we’ve seen many other (mostly temporary) market glitches ranging from erratic currency moves to liquidity issues in treasury markets. We are seeing the result of what happens when you superimpose mass speculation onto an environment of unprecedented global stimulus.
Let’s rewind a couple of months and clarify exactly how we got to this point. The world’s major oil producers manage the price of oil through OPEC. At the start of this crisis, OPEC tried to agree on oil production cuts between it’s various members in order to stabilise the oil price, given the huge slump in expected demand. Saudi Arabia was only willing to play ball provided Russia (not in OPEC, but in the OPEC+) would match these cuts. Long story short, Russia and Saudi Arabia had a little spat, Russia refused any production cuts, and the cartel was in disarray. The killer blow came shortly after, when Saudia Arabia upped the stakes and threw fuel onto the fire by announcing production increases. This turned out to be the catalyst that started the most rapid general market sell-off in history. Saudia Arabia essentially added supply-side shocks to existing demand side-shocks. Not only did the world now have less demand for oil, additionally the world had too much oil inventory almost overnight. Of course there was a political angle to this move. Saudia Arabia and Russia can withstand the lowest oil prices by far. Lower oil prices would ultimately flush out weaker competitors and increase their own market shares. Specifically some believe this move was aimed at the US shale industry which relies on much higher levels.
Fast forward to today: We’ve had months of low oil demand coupled with excess supply. Initially customers bought up oil at cheaper levels (some customers considered these prices the bargain of a lifetime). However, we soon ran into storage and capacity issues. Oil isn’t something you can just keep in your garage – in order to take physical delivery you need capacity, and storage costs are not negligible. Inventory levels are now so high (in a nutshell because we stopped flying and driving months ago) that there is no literally no place to put it.
And now onto specifically what happened last night: The May contract for WTI Crude oil temporarily collapsed and went as low as -40 dollars a barrel. This was a temporary state, as the same contract is now back in positive territory. Why did it happen? Simply put because there is SO little demand for oil right now, SO much supply and far to many speculative players (this is exacerbated by ETF activity). Essentially it means that currently nobody actually wants to take physical delivery of oil, and everyone is relying on hopefully being able to roll their contracts. What is the takeaway here? Don’t assume that ANY asset cannot possibly trade lower in an environment as stressed as we are currently in. Market anomalies are still present, and occasionally stimulus bandages fail to cover them up.
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