COVID-19 Pushes US Crude Oil Traders to Pay to Sell Oil

The COVID-19 crisis has destroyed the global demand for energy. The US crude oil prices traded below zero for the first time in history as West Texas Intermediate (WTI) May Futures contract settled at negative $37.63 per barrel. Simply it means that the producers are paying to get rid of their oil.
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Crux of the Matter

How Did it Happen?
To explain in the simplest of words: Crude oil supply didn’t fall and demand didn’t rise, resulting in this historic fall. Crude oil is one of the world’s most precious commodities and price changes in it affect the economic ecosystem right from family budgets to the nation’s GDP. 

Oil futures contracts are traded by the month and have never gone into negative before. The June WTI contract, which expires on May 19, plunged about 18% to settle at $20.43 per barrel. The July contract was about 11% lower at $26.18 per barrel. The international benchmark oil price, Brent crude also has fallen to 18-year low from January 2020 but is still above $20 a barrel.

Since the coronavirus pandemic began, many governments imposed strict lockdowns and restricted travel due to which the demand for oil dropped by one-third to about 29 million barrels a day and so dropped its price. The graph below depicts the fall of the WTI crude oil prices in the past 1-month span from $40 to a negative $37 due to the pandemic and worldwide lockdowns and

Crude Oil Futures Crash

Oil prices are volatile as they’re affected by the laws of supply and demand and prices are determined by oil futures contracts on the commodities markets. This basically means that commodities traders control oil prices and they go up if traders think there will be a surge in demand and go down if traders think there will be a drop.

1-Day Percentage Drop in Crude Oil Prices (1986-2020)

Who Wins, Who Loses?
During Iraq’s invasion of Kuwait in 1990, a trader took massive positions at cheap prices ahead of the invasion and sold them when prices rose after the invasion. Oil was stored in tankers floating on the sea and unloaded at considerably higher prices. Similar to this practice, taking advantage of cheap prices, many oil-importing countries are now storing large quantities of oil as reserves. In the graph below we can see the timeline of crude oil prices from 1950 to 2020. The prices went as high as $160 after the 2008 financial crisis and after which its downfall began.

Russia and Saudi Arabia depend heavily on its oil revenues to sustain their economies as 38.9% and 50% respective GDPs comes from oil. All oil-producing nations need higher prices to balance their budget and also account for their losses too. American shale oil companies find it very hard to survive if oil prices are low.

The world’s oversupply of oil is particularly critical in the US which produces 10 million barrels a day as compared to other regions like the United Kingdom where oil prices are still above zero because they have lower transport costs and easy access to ports. The reduced prices will be a boon for cash-strapped airlines as it will make it cheaper to operate flights but due to the worldwide lockdown, all the flights remain grounded and so is with other modes of transportation.

India’s fuel demand reached its lowest in 2 decades in March and declined by 17.8%. This benefits India as the foreign currency being spent to import the oil will reduce substantially giving relief to the growing concerns of the fiscal deficit. China is historically a stockpiler of oil when prices are low. The lower price of oil can benefit oil-importing nations.

The Demand-Supply Mismatch
Keeping in mind the reducing demands, OPEC+ had agreed to cut production by 9.7 million barrels a day which still is very less as there is already a huge surplus of oil in the market with no buyers and nearly filled storage capacities.

OPEC and its members were abiding by an agreement to limit production but it expired on March 31 and later Russia refused to lower production after which the OPEC+ responded by announcing an increase in production. Oil producers continue to produce crude from their wells causing a major imbalance between supply and demand.

Storage Capacity Running Out
The oil demands have hit a 25-year low as the pandemic has devastated all areas of the economy making practically impossible to travel by road, air or water. According to energy experts, there is an estimated storage capacity for 6.8 billion barrels in the world out of which nearly 60% is filled and with increasing difficulties to find storage spaces the companies could be forced to shut down their wells.

People are concerned that we are going to see so much build-up of inventory that it’s going to be very difficult to fix in the near term and there are going to be a lot of distressed cargoes on the market.

Michael Lynch, President of Strategic Energy & Economic Research Inc

According to a report in the Wall Street Journal, hiring charges have increased multiple times as there is a growing demand for floating storage to take advantage of low prices but that too will soon run out of capacity. The floating storage has risen by 120% in the past 8 weeks to a record high of more than 120 million barrels which is more than double the seasonal norm wherein the highest growth is seen from the Asia-Pacific region.

India has been filling its strategic reserves by taking advantage of the cheap prices. India has a capacity to hold over 39 million barrels at its strategic reserves in Vishakhapatnam, Mangalore, and Padur (Udupi).

As of now, the plan is to fill the caverns by the 3rd week of May before the arrival monsoon rains. We are buying oil from state refiners.

H.P.S. Ahuja, MD Indian Strategic Petroleum Reserves Ltd (ISPRL)

Hopes Of Recovery
It is highly expected that the oil prices recover very soon as in the month of May the oil demands are expected to be lowest and supplies are expected to be highest. Soon oil traders will begin trading barrels for delivery in June and these are expected to fetch far higher prices. A significant recovery will depend on demand for transport fuels which will increase only if lockdown ends and markets open up.

Since the global economy is in a recession and a lot of uncertainty prevails it is difficult for anyone to predict the growth of the oil prices after the pandemic subsides. The longer this pandemic lasts, the greater the damage oil producers will suffer.

  • Brent crude and West Texas Intermediate are the two main benchmark prices for purchases of oil worldwide. Brent is the leading global price benchmark as it is used to set the price of two-thirds of the world’s internationally traded crude oil supplies.
  • Big Oil is a name used to describe the world’s six or seven largest publicly traded oil and gas companies, also known as supermajors. The supermajors are considered to be BP, Chevron, Eni, ExxonMobil, Royal Dutch Shell, Total, and ConocoPhillips.The use of the term in the popular media often excludes the national producers and OPEC oil companies who have a much greater role in setting prices than the supermajors.
  • Royal Dutch Shell PLC, commonly known as Shell, is a British-Dutch oil and gas company. It is one of the oil and gas “supermajors” and the third-largest company in the world measured by 2018 revenues (and the largest based in Europe). On the occasion of International women’s day (8th march), Shell changed its name to “She’ll” for a day.