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WTI crude oil crash: Is this start of new normal for oil?

 

  • WTI crude oil (immediate delivery futures) traded into negative territory
  • Reasons driving the price drop
  • What is expected in the near-term?

 

Since the coronavirus pandemic breakout early this year, financial markets all around the world have seen many rough and unprecedented swings. But what happened on Monday 20th April 2020 was the wildest move when the near month WTI futures (US oil benchmark), crashed and plunged below zero for the first time in history.

The price on WTI (West Texas Intermediate) crude future, with expiry on Tuesday 21st April,2020, nosedived as low as to an all-time low of minus US $40.32 a barrel, before settling at minus US $ 37.63 a barrel. The negative price of any contract means holders of long position have to pay holders of short positions to get rid of their contract to avoid taking delivery of underlying asset, which in this case is “OIL” at the Cushing hub, Oklahoma. In simple meaning, sellers are paying to buyer of crude oil at WTI.

 

 

What’s the reason behind epic fall?

COVID-19 pandemic has sent 90% of the world into lockdown, bringing the global economy to a standstill. Factories are shut, travelling is banned, economy is contracting, so the demand of crude oil. Currently, global crude oil demand has reduced as much as ~70% to 29 million barrel per day (bpd) in the very short term from about 100 million bpd a year ago in 2019.

OPEC (Organization of the Petroleum Exporting Countries) and its allies, including Russia, have announced earlier in April 2020 to cut crude oil output by ~10% or 9.7 million bpd. But this cut won’t happen before May nor considered enough than the demand reduction expected for the full year, leaving a huge surplus of oil in the market with virtually no buyers. As the supply of oil continues and demand is decreasing, the glut of crude oil is quickly filling up storage facilities globally. According to weekly data by EIA (U. Energy Information Administration), U.S. crude oil inventories as of 10th April were 6.2% above the seasonal 5-year average. Crude explorers have shut down 13% of the American drilling fleet in mid-April. Though production cut has started, it is not happening as the pace of decrease in demand to avoid storage filling to its maximum level and thus, American energy companies are now running out of space to store it. According to EIA, crude stockpiles at Cushing hub, which is the delivery point for WTI future, have reached to nearly 55 million barrels since the end of February 2020, an increase of nearly 48%. EIA has also reported that Cushing has a working storage capacity of 76 million barrels only as of 30th September 2020.

The concern over lack of immediate storage space has sent prices to negative zone as if there is no place to put the oil, no one wants a crude contract that is about to come due for physical delivery. On 15th April, CME group (holding company of NYMEX) issued an advisory to allow certain NYMEX futures to trade at negative or zero prices, also settle at negative or zero prices due to current oil market environment. On Monday 20th April, it gave a special dispensation to allow crude oil prices to turn negative as there could have been sever physical delivery problems in absence of immediate extra storage capacity at Cushing hub when the contract expired on Tuesday 21st April 2020. As a result, WTI for May delivery plummeted as low as negative $ 40.32 a barrel, far below the lowest level previously seen since 1946.

 

Will this price sustain?

Since start of 2020, COVID-19 impact together with breakdown in the original OPEC+ agreement has resulted into fall in oil prices. Production cut to curb supply is not resulting into immediate need to stop oversupply, hence, resulting into fire sale by traders around the globe who don’t want to take physical delivery in absence to have access to storage.

However, it is interesting to note that while WTI crude oil crashed, ICE’s Brent crude were still trading in the green above $ 20 a barrel. The wide gap between two crude oil grades surfaced as WTI’s delivery at Cushing hub was facing storage issues while Brent’s delivery can be happened offshore at multiple location. The shortage constraints at Cushing hub led to price fall for May contract though positively, much of the fresh trading has already moved to the next month’s contract, i.e. June delivery which touched a low of near $10 as its preceding contract moved into negative zone.

In a nutshell, the oversupply situation and internal issue over storage and delivery led to the irrational movement of the prices of the black liquid during the past week. With demand at near complete halt in the short-term, and oil production in the US largely stable till recently, hundreds or even thousands of small-scale players face the issue of going into bankruptcy if prices continues to trade low. Already, most regions are facing a scenario in the US wherein production has been halted or going to be trimmed as prices hover below marginal cost of production. Practically, near-term fate of the commodity depends on how long the lockdown stays globally and in the US, alongside the fact that how much time it takes to overcome from coronavirus pandemic. We expect, crude prices will remain under pressure in short run till the fall in production doesn’t meet the reduced demand worldwide or we see some positive news regarding the diminution in the pandemic.  

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