Investment News: A truly historic day in the oil market

What investors witnessed yesterday in the oil market was truly unprecedented. The price for a barrel of WTI went negative. The lowest price seen during European trading hours was 10.01$pb, which comes close to the historical price trough of 9.75$pb, back in 1986. By then, the spread between the upfront contract for May and the next one in June reached over 12$, also a true outlier, indicating a massive contango effect. Finally, the spread between the front contracts for oil Brent and WTI climbed to 16$, which is a 5-standard deviation from the 1.5$ average. Turning negative was never seen before and might be a stark warning for future contracts like the ones for June.

What are the causes of the crash ?

The main reason for this event is technical: with the May contract expiring today, most financial traders, often lead by ETF-driven flows, were trying to square their positions before getting stuck and forced to accept a physical delivery. With a lack of access to storage, there has been a fire-sale. Oil storage has become the big problem where the most important storage center in the US, i.e. Cushing, Oklahoma, is filling up at an unprecedented rate. Oil stocks rose by 18 million barrels during the past 3 weeks, which concurs with 20% of its total capacity. By the end of February already, stockpiles at Cushing had jumped to 55 million barrels, versus a total capacity of 76 million barrels, according to the EIA. It implies that storage capacity at Cushing is now exhausted.

The future isn't bright for the shale oil industry

While the number of rigs continues to decline in the US, drillers are still producing in order to create cash-flow. Nevertheless, the price they are receiving to get the oil off their hands is falling sharply. For some oil streams, prices as low as 2$pb are being paid and some oil market specialists believe negative prices will be possible. No doubt about it, carnage is happening in the shale oil industry.

The solution sounds simple

The solution to the problem is of course less production and an increase in storage capacity. Recently, rumors were swirling that the US government would use their strategic reserves storage capacity to help out the US oil industry. Increased consolidation within the industry and thus lower production is also an option as giants like Chevron or Exxon pick up the pieces.

In brief, the double whammy of oil surplus and falling demand hit the oil sector hard. There aren’t many options to get out from this mess. The corona crisis is not set to disappear overnight and hence demand could remain fragile for a while yet. Meanwhile the US oil sector is getting crushed.