Why Oil Prices Went Deeply Negative

Today U.S. WTI crude oil prices fell to negative prices, at one point -$40.32 per barrel. The big question is: How can this happen?

Commodity Benchmarks

Although it may not be the most unique thing that defines commodities, pricing by an agreed upon uniform benchmark is absolutely critical to the transactional value and usefulness of commodities. The ability to trade something consistently allows for numerous transactions to occur without customization and provides a commodity with both liquidity and marketability.

All benchmarks include three critical components:

§ Quality specifications

§ Timing of delivery or pricing

§ Geographic terms

WTI Crude Oil Benchmark Risk

For U.S. West Texas Intermediate crude oil, like all commodities, there are quality, timing, and geographic requirements. The reason prices went negative today is because WTI is a physically settled contract for crude oil at Cushing, Oklahoma, and sometimes financial markets can go negative.

It's happened to interest rates.

And now it's happened to crude oil prices.

This means that WTI futures require the contract buyers actually receive physical crude oil at Cushing, Oklahoma. If the contract expires and you own it, you're going to get a call to come get your oil.

But not everyone wants that physical risk. 

Normally, the physical risk isn't a big deal, and the oil can be put in storage or put in a pipeline and taken to a refinery. But the storage at Cushing, OK is quite full. And the pipelines are quite full.

After all, with "shelter in place" going on right now, refineries have massively reduced operations. If people aren't driving to work or flying, the economy needs a lot less fuel.

This is why WTI prices fell so negatively today.

It also happened to be the day before the WTI contract for May closes, and buyers were trying to get out of their physical positions. They were so desperate to dump crude oil, that not only could you "not give it away," but at some point, some traders were willing to pay over $40 per barrel to have someone take the oil from them.

There just isn't really anywhere for the oil to go, and no one wants to be left holding the hot potato - especially with a risk that crude oil storage costs at Cushing - or transport costs away from Cushing - could be astronomical.

This is what the storage tanks at Cushing, OK look like.

The Big Brent Crude Benchmark Difference

If you're looking for proof that the storage situation at Cushing is to blame, look no further than another oil price benchmark: Brent crude oil prices.

Even though WTI crude oil prices were deeply negative today, Brent crude oil prices were not. In fact, they were a lot higher than WTI crude oil prices, with Brent ending the day at +$26.07 per barrel.

So why was there such a big difference - almost $50 per barrel - in price between the positive Brent and the negative WTI?

Well, let's compare U.S. West Texas Intermediate Crude Oil, WTI futures, and British North Sea Brent Crude Oil futures. 

Physical and Financial Settlement Explained

As I noted above, WTI crude oil futures are physically settled. But Brent Crude Oil futures can be financially settled. And these contracts do not require buying physical crude oil in the North Sea. 

This means that you don't have to sport a kilt and show up in Scotland to come get your crude oil. It's all financially settled. 

But if your contract closes in Cushing, you're off to Oklahoma to get your crude oil if you can't find somewhere to store it. Let's hope you've got a big tanker truck!

Another important thing to know about futures is that they are settled on a daily basis. And daily settlement reconciliation can have significant and potentially negative cash flow implications. This is something companies are likely feeling today, as companies that planned to save money by locking in crude prices at a certain level may now owe very large amounts.

For a further discussion of the difference between WTI and Brent crude oil prices, check out my course video on Finance Foundations: Risk Management -

What's Next?

The storage risks for crude oil and petroleum products are very unique and are not the same as storage for metals, for example, which can be placed in a much less complicated and controlled warehouse.

Nevertheless, the uniqueness of today's situation is likely to have negative implications for oil and gas companies and other financial markets.

Plus, it reminds us that almost anything can happen in financial markets.

Be careful out there!

The Future After COVID

To read more about what could happen to energy markets in the post-pandemic period, check out Jason Schenker's book, The Future After COVID, which was released on 1 April 2020 and is a No. 1 New Release for Macroeconomics on Amazon.

This article also includes excerpted material from Jason Schenker's book The Future of Energy: Technologies and Trends Driving Disruption, which was released in May 2019 and became a #1 Best Seller on Amazon.

The Future After COVID is online here: www.FutureAfterCovid.com

Jason Schenker is one of the world's leading financial market forecasters and energy analysts. He is the Chairman of The Futurist Institute and the President of Prestige Economics. Jason was previously a Risk Specialist for McKinsey and Company. Prior to McKinsey, he was the Chief Energy and Commodity Economist for Wachovia Bank.

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