Below zero: oil plunges into negative territory

US oil’s unprecedented collapse is mostly due to how it is traded – but also to the shock to global GDP, says Alex Rankine.

American oil magnate John D. Rockefeller once said that “we are refining oil for the poor man and he must have it cheap and good”. But as the “Ghost of John D. Rockefeller” twitter account quipped this week, “I didn’t mean this” cheap.

The plunge is due mostly to the technicalities of how oil is traded: using futures contracts. These are deals to buy and take delivery of oil, or sell it, at a certain point in the future. Futures cover various periods of time, from one month to several years. The price typically quoted is for the front-month, or current one, and this is where the collapse occurred.

The price of US oil benchmark West Texas Intermediate (WTI) plunged by more than 300% on Monday, taking prices for delivery next month from $17.85 a barrel to an unprecedented minus $37.63 at the market close. European prices have remained above zero, but Brent crude (the benchmark non-US futures) had still tumbled 22% to a 21-year low around $15 a barrel by mid-week.

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Demand for oil is plummeting

The trigger for the fall in the price of the May WTI future was plunging demand. The International Energy Agency forecasts that global oil demand will fall by 29 million barrels per day (mbpd) this month, a decline of about one-third compared with last year’s levels. That has created a huge surplus, recently thought to have reached about 20mbpd.

With demand plummeting, the price of a contract to take delivery of oil in May duly plummeted too. Traders who are used to working on computer screens without the risk of “getting any oil on their expensive suits” panicked, writes Neil Irwin in The New York Times. With the delivery date for May’s oil contract fast approaching, there were no buyers for their oil paper and no storage space available to put it in the meantime. That forced them to pay businesses that are equipped to handle the delivery of thousands of gallons of a volatile, toxic fuel to take the problem off their hands. The result was negative prices.

Trouble in America

America has emerged as the world’s top petroleum producer in recent years, but the country’s storage and transportation infrastructure has struggled to keep up, says Spencer Jakab for The Wall Street Journal. European crude traders have opted to “wait out the price slump at sea”, says The Economist, paying $200,000 a day to charter crude tankers to store excess oil. Yet landlocked American oil producers have no such storage fallback. The result is that the country’s oil has become “less than worthless”.

It doesn’t help that US producers have been slow to turn off the supply taps, says Lex in the Financial Times. More than 12 million barrels of oil still come onto the local market every day despite the existing glut. Negative oil prices can also be understood as representing a shortage of available storage and right now “oil storage space is like gold”.

The bigger picture: a deflationary shock

This slump is more than a mere quirk, says John Authers on Bloomberg. We are entering a brave new world: oil hasn’t been this cheap in real terms since Richard Nixon ditched the dollar’s peg to gold in 1971, the event that marks the start of the modern financial regime. The fuel has fallen so much that Microsoft Corporation alone is now worth about as much as “the entire market value of all the energy and materials companies in the S&P 500” combined.

Negative oil prices are more evidence of the “extraordinary deflationary shock” that Covid-19 has dealt to the economy, says Irwin. As global demand for goods and services evaporates over the next few months oil may not be the last market to experience such a severe price slump.

A crude awakening

Most of the immediate pain of negative oil prices was probably limited to “a small number of speculative investors” caught on the wrong side of the price swing, says Mark DeCambre for MarketWatch. Yet evidence that the oil market is “unravelling” has knocked confidence hard. “America’s oil patch is having a heart attack” as more and more heavily indebted producers are forced to turn off the taps, says Jakab.

A return to negative prices cannot be ruled out, says Samuel Burman of Capital Economics. The June WTI price is in positive territory for now – although it has slipped below $10 a barrel – but it could run into exactly the same storage problems this time next month. Plummeting Brent crude prices suggest fear that international prices could go the same way as American ones. A volatile few months are in store for oil.

The outlook for the second half of the year, however, is improving. Output cuts by key producers Opec and Russia removing almost 10mbpd from global supply will start in May, while the latest price crash could prompt even deeper cutbacks on the US shale patch. Any easing of lockdowns could also help demand tick back up. Prices look set to stabilise in the second half. A new bull market, however, remains a distant prospect.