A worker prepares to lift drills by pulley to the main floor of a drilling rig in the Permian basin.
Brittany Sowacke | Bloomberg | Getty Images
Something that’s never happened in the oil market is happening today: Negative prices for oil contracts.
While many people may see this and think the overall price of oil is negative, there’s nuance. The short answer is that no, not all oil is free.
The picture in the market is not as bleak as this eye-popping headline would suggest.
Futures contracts are tied to a specific delivery date. Toward the end of a contract’s expiration date, the price typically converges with the physical price of oil as the final buyers of these contracts are entities like refineries or airlines that are going to take actual physical delivery of the oil.
Futures contracts ultimately are contracts for physical delivery of the underlying commodity or security. While some people in the market speculate on the contracts, others are buying and selling because they have use for the commodity itself. Near the contract’s expiration, traders just start buying the next month’s futures contract. Those who stay in the position to the final day are typically buying the physical commodity, such as a refiner.
The contract that fell more than 100% on Monday is for May delivery, and it expires on Tuesday. With the coronavirus pandemic leading to unprecedented demand loss, and with storage tanks quickly filling up, there is no demand for this oil contract expiring Tuesday.
That’s why it turned negative, meaning producers would pay to get this oil off their hands because there is no one that needs that oil this week with the country shutdown.
Futures contracts trade by the month. The contract for June delivery traded 16% lower at $21.04 per barrel.
So after that contract expires on Tuesday, oil will be back above $20.
The U.S. Oil Fund, which tracks the price of various futures on oil, fell just 10%.
Trading volume was also relatively thin in the May contract. According to data from the CME Group, volume stood at roughly 126,400. By comparison volume for the June contract was nearly 800,000.
Again Capital’s John Kilduff attributed the plunge in the May contract to the fact that “the physical oil market conditions are a disaster, with growing concerns about finding available storage.”
Longer-term, he said the picture looks brighter.
“The higher priced, longer-dated futures contracts are indicative that of the market expecting some level of clearing in the cash market over the course of the next several months,” he told CNBC. “Given the rapid decline in the U.S. oil rig count and the expected cutback by OPEC+ members that is a reasonable assumption.”
That said, he noted that as the subsequent contracts reach expiration, they could engage in their own “death march down towards the super-low cash prices.”
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Published at Mon, 20 Apr 2020 18:34:57 +0000-This oil price crash isn’t as bad as it seems — here’s why