Behind the great oil collapse
US oil futures crashed below zero due to a storage crisis – but will Brent, benchmark for the rest of the world, follow suit?
US oil prices turned negative for the first time in history on Monday, crashing through the floor to -$40 at one point. It is unprecedented for sure. But so is the simultaneous seizing up of world economies.
As governments around the world impose lockdowns to slow the spread of Covid-19, demand for oil has, quite simply, fallen off a cliff. And so has the price.
The market is in crisis.
That became irrefutable on Monday when the futures price for West Texas Intermediate (WTI), the US benchmark for crude, turned negative, plummeting to -$40 a barrel for May delivery over fears that storage capacity will run out.
Primarily, the price crash affected US oil producers, which base their prices on WTI crude. About two-thirds of the world, including SA, mainly use Brent crude oil, on which our petrol prices are based. Though the price of Brent crude didn’t crash, and remains around $20 a barrel, it exposed deeper concerns about the fragility of the entire oil market.
Sasol, one of SA’s most widely traded shares, which makes fuel from coal, recently hedged itself against a falling oil price at $32 per barrel until the end of June.
Up until two weeks ago, Saudi Arabia — the world’s lowest-cost producer of oil — was flooding the market, seemingly to spite Russia for its refusal to cut production.
The feud came to an end this month when Opec and its allies resolved to implement enormous, staggered productions cuts until April 2022.
But it’s too little, too late. The world is swimming in cheap crude oil and demand has dissipated.
The only thing traders can do is hold on to it in hopes of making a handsome profit later. As a result, the world’s oil storage facilities are rapidly reaching capacity.
In the US, the storage concern that led to the WTI price crash appears to have centred on particular issues with a major facility in Oklahoma, which is expected to reach capacity within weeks.
The crisis came to a head on Monday because May contracts expired on Tuesday but sellers and buyers did not know if they would have anywhere to store the oil. Sellers were effectively paying customers to take their product.
According to Bloomberg, the May prices moved back into positive territory on Tuesday morning — albeit to just $1 — and June prices were trading at $20 a barrel.
Some say the negative US oil price is a once-off phenomenon, while others believe it could dip below zero again next month if the prevailing issues persist.
Could Brent suffer the same fate? "There’s no reason it can’t," says Craig Erlam, a market analyst at Oanda. "It’s simply a matter of how much capacity there is at the storage facilities. If they fill up and production is still far greater than demand, it will happen."
Conventional oil storage everywhere is filling up. As recently reported by The New York Times, the world has an estimated storage capacity of 6.8-billion barrels, and experts say nearly 60% of it is full.
According to SA’s Strategic Fuel Fund, storage tanks at Saldanha Bay — the largest oil facility in the southern hemisphere — are not yet at capacity but all allocation is spoken for. Meanwhile, oil traders are scrambling to lease supertankers to store oil at sea.
But Abdul Davids, head of research at Kagiso Asset Management, sees the negative oil price as peculiar to the US, where rampant production is also a factor. "The same underlying fundamentals of massive inventory amid weak demand is prevailing in the Brent market as well, though not to the same extent," he says.
"This negative price only relates to the WTI futures contract that expired on Tuesday, and is a physical delivery contract," he says. Traders couldn’t sell the contracts because buyers were unable to purchase them without storage to take delivery.
Richard Cheesman, senior investment analyst at Protea Capital Management, agrees. Unlike cash-settled contracts, physical settlement means buyers had to take delivery of the goods. "It’s a technical issue and in and of itself won’t have a significant impact on producers elsewhere."
Though storage limits and low demand could well push Brent lower too, he does not expect it to drop below zero.
Erlam notes that Saudi Arabia, Russia and others can implement cuts more quickly than the US can, which arguably makes a negative Brent price much less likely.