A Black Swan In Oil

May 11, 2020

‘Full Storage’ Fears
By late March, it was becoming apparent that no amount of artificial supply cuts from OPEC or Russia was going to offset a nearly 30% drop in global oil demand. The market would have to hold all of the excess supplies in storage until demand recovered enough to close the gap.

The only problem? Storage tanks were filling up so fast that space to put fresh oil was becoming scarce. The industry was not set up for such an enormous decline in demand.

As the devastation within the energy industry spread, anxiety began to grow. Even President Trump, concerned about the impact low prices were having on the U.S. shale industry, was rooting for higher prices. Out of nowhere, the president claimed to have gotten OPEC+ to slash output by millions of barrels per day. Days later, the deal was miraculously clinched when Saudi Arabia, Russia and their allies announced a massive 9.7 million barrel per day output cut, the largest ever.

But oil prices hardly flinched. The day after the cut was announced, WTI sagged 1.5% and then plunged 10.3% the next day. After a brief countertrend rally, prices were back to $20.

Prices continued to drift lower throughout that week. That Friday, they closed at $18.27, two days ahead of the expiration of the May WTI futures contract. No one could have imagined it then, but the oil market was about to be turned on its head on Monday.

Twilight Zone
April 20, 2020 is a day that will forever go down in history as the day oil prices entered the twilight zone. From $18.27 the previous Friday, WTI collapsed by 306% to settle at -$37.63 by the end of day Monday. That’s right—negative 37.63.


How that happened is still being debated today, but one thing that’s certain is that the oil market had entered that day in an extremely fragile state. Storage levels were rising fast and there was no telling whether there would be any space left to store excess crude in the coming weeks.

With few able to secure storage space, the front-month futures contract for May delivery turned into a hot potato. Some traders, who even ordinarily wouldn’t take delivery of physical oil, were eager to get out of their positions, but had limited buyers to take the contracts off their hands.

U.S. oil-tracking funds like the United States Oil Fund LP (USO) had already rolled their positions into subsequent June contracts well ahead of the May contract’s expiration, but other financial players remained. They had to get out—at any price—and that desperation may be what fueled oil’s descent below zero.

The Aftermath
Oil’s foray into negative territory was brief. The next day, the May contract expired at $10.01. The June contract—which is the front month as of this writing—never got below that level, and has since rebounded to $24.03, suggesting that “full storage” isn’t yet a reality.
In addition to the nearly 10 million barrels per day worth of OPEC+ cuts that have gone into effect, U.S. oil producers have announced production curbs of their own totaling more than 1 million barrels per day, with more to come. The IEA expects that output from non-OPEC countries could tumble more than 5 million barrels per day by the end of the year.

These are massive numbers that have spooked oil prices back up to where they were in mid-April. Whether they can rally further from here in the short term remains to be seen.

After all, the prospect of inventories filling up remains a possibility with demand still in the dumps. The question is, can economies reopen fast enough, and can demand rebound fast enough, to get supply and demand back into balance before that happens?

That will determine whether the unprecedented negative oil prices seen in April will remain unprecedented.

Longer term, it looks as if oil prices will be on much firmer footing. The damage that 2020’s downturn so far is doing to energy sector investment is immense. Supply in the coming months and years will pay a price for that.

Contact Sumit Roy at [email protected]

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