Oil industry: negative prices a reality check

If the oil industry wasn’t taking the level of demand destruction seriously, it certainly will now after crude oil futures went negative.

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The West Texas intermediate (WTI) May futures contract traded as low as $US40 per barrel (/bbl) as buyers deserted the market.

"Physical buyers in the US are reluctant to take on more crude at the moment. Storage facilities are filling fast.”

With the WTI May futures contract due to expire, anyone holding a contract would be forced to accept physical delivery. With storage facilities filling fast, particularly at the WTI pricing point – Cushing - there were fears there would be nowhere to store it. The contract eventually closed the session at -$US37.63/bbl.

While negative prices are hard to fathom, they are rooted in reality.

Many physical crudes in North America have been trading in single digits for weeks. Bakken crude, a major oil product in the US, fell below $US9/bbl last week. West Canadian Select, another major crude fell as low as $US4/bbl two weeks ago.

So it’s no surprise that as the front-month futures contract reaches expiration, it has naturally gravitated towards the spot price.

Physical buyers in the US are reluctant to take on more crude at the moment. Storage facilities are filling fast. The Energy Information Administration (EIA) reported in October that storage capacity was around 426.5 million bbl and was 55 per cent full.

Using inventory since then, ANZ Research calculates that capacity utilisation has risen to over 81 per cent.

The weak physical prices reflect the market fundamentals which have been under pressure since lockdowns and travel restrictions around the world due to COVID-19 stymied demand. There are also concerns travel restrictions may stay in place for the immediate future, despite the US White House talking about easing.

The Organization of the Petroleum Exporting Countries (OPEC+) supply agreement should stem the flow of oil into storage tanks in the medium term. In the US, the number of drilling rigs are falling, which should see US shale output start to fall in coming months.

ANZ Research suspects the WTI June future will come under pressure unless there is more immediacy around supply closures. This may come via forced closures or even bankruptcies in the US shale industry.

ANZ Research would expect OPEC+ members to talk about bringing forward their planned production cuts from the recent supply agreement. The 9.7 million barrel per day reduction is scheduled for 1 May.

Even so, ANZ Research sees it having minimal impact on crude oil prices in coming weeks.

Daniel Hynes is Senior Commodity Strategist and Soni Kumari is Commodity Strategist at ANZ

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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