April 23, 2020
John LaForge, Head of Real Asset Strategy
Oil Goes Negative–What Does It Mean?
- The price of West Texas Intermediate (WTI) crude oil closed below zero on April 20.
- Collapsed oil demand and fears that storage would soon be filled were the primary factors that led to oil prices going negative this week.
What it may mean for investors
- We expect oil markets to remain nervous in the short run as supplies and storage are adjusted against stagnant demand. In the coming months, we expect to see some deep supply reductions and a swath of shut-in oil fields, particularly in the U.S. By year-end, we expect to see higher prices.
The coronavirus has brought with it many firsts. The latest came this week in the commodity markets. For the first time ever, the price of WTI crude oil closed below zero. Yes, it actually went negative. On Monday (April 20), the May WTI futures contract settled at -$37.63 per barrel. This was after closing the previous Friday (April 17) at $18.27. The questions are coming fast and furious, so let’s do this. Straight from our email inbox, here are the most asked questions and our answers.
Have you ever seen oil prices go negative?
No, we have not. Negative oil prices are exceedingly rare. On select occasions in the past, we’ve seen other commodities briefly cross into negative territory, but never WTI crude oil. WTI is the main U.S. crude oil benchmark, cited often by investors and news outlets.
Did all global oil prices go negative?
No. The futures contracts that turned negative were a very small, very select group of oil futures contracts tied to U.S. and Canadian crude oil. Importantly, these futures contracts were set to expire over the coming days. For perspective, there are more than 140 different global crude oil blends—WTI being one.
Why (how) did this happen?
Short answer—the economic fall-out from the coronavirus pandemic. It would be an understatement to say that shutting down the world has had its economic consequences. No past event could have prepared us for such swift crude oil demand destruction (Chart 1, orange line). Global production (Chart 1, dark purple line) has fallen, too, but not as fast as demand, and this is key. This drop in demand has left a lot of extra oil barrels looking for “storage” homes. Many have found homes, but global storage is filling up quickly, especially in the U.S. Fears that storage would soon be filled is what led to oil prices going negative this week.
Why would oil prices go negative over only the “fear” that storage might not be available?
The answer lies in how a futures contract works. Simply—there is a buyer and a seller for every futures contract. Each side has its responsibilities. The part that matters most to this answer is that buyers are obligated to take physical delivery of crude oil at a specified future date. To do this, buyers need to know that they have a place to store it. This was the problem with the WTI May 2020 futures contract that went negative this week. Buyers of record as of April 21, 2020 were obligated to accept physical oil from the seller on May 20, 2020.
Unsure that storage would be available a month from now, buyers stampeded over one another to exit the May 2020 contract before they became the official buyers of record. By the time the dust settled on April 20, exiting buyers were paying other buyers $37 (thus putting the negative in -$37 per barrel) to take the futures contract off their hands. And the rest is negative history (Chart 2).
Is U.S. oil storage full?
No, it is not. We’re still likely weeks away from that, if it does happen at all. The blue line in Chart 3 shows oil storage capacity in Cushing, Oklahoma, which is the main delivery point for WTI oil. The top grey line would indicate a “full storage” level.
Keep in mind that storage is a flexible number. No one really knows for sure what “full” is, in the U.S. or globally. That’s because crude oil can be stored in everything from tanks and ships to caves and tubs. The world has never seen “full,” which is part of what made negative prices this week so shocking.
If negative prices were seen in only a handful of U.S. oil contracts, why all the media clamor?
WTI has global brand recognition. The U.S. is the world’s largest crude oil producer, and WTI is its main benchmark price. WTI has its own ticker on financial television. Its name recognition is up there with the Dow Jones Industrial Average, the S&P 500 Index, and gold. Add the fact that a main oil benchmark price went deeply negative, and it became a big story.
Does oil going negative concern you about your favorable view on commodities?
No, it does not. In fact, we see this week’s events as more positive than negative for this call. As the saying goes, “the cure for low commodity prices is low commodity prices.” Our favorable view is a tactical one, which means a 6- to 18-month timeframe. We expect that oil’s 2020 performance is very likely to weed out a substantial amount of marginal global production for years to come. The result 6 to 18 months from now, we believe, will be good for oil prices—and for our overall positive commodity outlook.
Could the negative oil price have anything to do with the rise of electric cars?
Good question, but no, we don’t think so. Electric cars, while rising in influence, remain inconsequential to the global oil demand story at this time, in our view. Ask again in 10 years.
Do you believe negative oil prices could be a sign that the global economy is weaker than feared?
We doubt it. This week’s action seemed to us to be more about oil, and fears surrounding its physical limitations. WTI futures beyond the next few months are priced much higher, some even above $30. The severe WTI price dislocations are happening in the contract months nearest to us now, which tells us that oil is not likely signaling an even deeper recession than we are already calling for.
Could this mean that oil is losing its long-term economic relevance in the world?
We doubt this. World economies remain addicted to oil, and we do not see this changing anytime soon. As world economies grow, and standards of living rise, so should oil use. This is roughly what Chart 4 is showing us. Once this coronavirus economic air pocket has passed, we believe the world will very likely return to its old trends – wanting to continue to raise the global standard of living (Chart 4, orange line)—and with it should come growing oil consumption.
What happens next?
Over the short-run, we expect oil markets to remain nervous as supplies and storage are adjusted against stagnant demand. We expect oil markets to remain volatile as we approach summertime, but we do not expect months and months of negative oil prices. Negative oil prices are rare, almost freakish events. Then again, so are pandemics.
By the end of 2020, we expect to see higher prices. We expect to see demand rebound some, but the main driver of the year-end price rise will be the growing reality that supplies have dwindled. Over the coming months, we expect to see some deep supply reductions and a swath of shut-in oil fields, particularly in the U.S.
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