Just like flush liquidity that turns interest rates negative, prices for West Texas Intermediate (WTI) plunged into negative territory for the first time ever, underscoring a situation of too much oil, with nowhere to put them. Oil storage capacity filling towards the brim in the US has prompted a dramatic drop of the May WTI futures contracts – which expire today – to as low as -USD40.3/bbl at one point overnight.
Rising US commercial inventories of crude oil
Source: EIA, Bloomberg, Bank of Singapore
The WTI oil market is a reflection of the supply glut in Cushing, not a reflection of the international oil market, which more closely follows Brent crude. Additionally, unlike Brent, the WTI contract is settled through physical oil delivery, i.e. the owner of the contract gets barrels of crude on the day of expiry. With storage facilities filling up fast, particularly at the WTI pricing point in Cushing, there are fears that there will be nowhere to store them. Only those who can take physical delivery can make a financial gain from the collapse of the WTI May futures contract into negative territory. There are not many in this group, which excludes the large number of financial players, given that storage capacity for WTI is almost maxed out.
On top of an increasing inability to store crude, sellers of physical crude are under additional pressure from sharply lower refinery demand for crude due to weak refining margins. Although the May WTI contract has moved strongly negative, June WTI – which will become the new front-end contract today -- is still priced around USD21/bbl.
Ripple effects into petro-currencies such as CAD, NOK and RUB have been modest so far. The front WTI price collapse likely overstates the (admittedly poor) fundamental outlook for oil prices for two reasons.
First, oil storage constraints are a more pressing issue for the US and WTI crude, as opposed to Brent crude, which is a more relevant pricing benchmark for the international oil market. Brent oil prices, which should be better supported by the announced OPEC+ supply cut of 9.7mbd, do not face the same acute storage shortage. Front-month Brent price declines were much more modest. Second, a possible reversal of the lockdowns lifting oil demand and non-OPEC supply cutbacks (i.e. production shut-ins by North American oil producers) could help tighten the market in the second half of 2020 and beyond.
The severe contango in the WTI curve beyond the front-month contract suggests that near-term downward pressure on oil prices will remain intact. It is too early for a sustained rebound in oil prices notwithstanding the OPEC+ deal although we see scope for a noisy bottoming out of oil prices in the next few months. Oil is a story of low prices now for higher prices later, with a more-painful adjustment in non-OPEC supply as the next most logical event.
Oil futures curve tells a story of low prices now for higher oil prices later
Source: Bloomberg, Bank of Singapore
We continue to expect a rebound in Brent crude prices to USD45/bbl in a year’s time. Lower oil prices are a boon for consumers everywhere, especially for much of Asia. However, the benefit for the broader economy would have to wait until economies reopen.
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Version: March 2020