The Phil Flynn Energy Report
Negative Oil! The Market Works
Oil pressure is growing as global storage fills up and OPEC fails to speed up production cuts. There are also criticisms directed at the CME Group for allowing negative oil pricing. Yet negative oil pricing wasn’t a sign that the oil futures contract was broken. Those negative prices were fixing a problem where the physical market was broken. It shows that the market works and works better with free price discovery afforded to the world by the futures markets. Beyond all the bearishness, the EIA showed signs that massive demand destruction may have bottomed out and the market might try to look ahead to better days.”
The plunge to negative oil prices — WTI came into delivery with more sellers than buyers — created a situation where we witnessed the market working. Despite criticism of the CME Group for allowing negative pricing and the fear that the move into the abyss forever redefined the inherent risk for commodities, in reality, the market did what it had to do. It found buyers for a commodity that no one currently wanted and found storage for that oil that was supposedly nonexistent. Once word got out that they were actually paying people to take oil away, potential buyers for that oil sprung up out of nowhere. Physical buyers of oil who realized that this may be a once in a lifetime opportunity to buy oil and lock in a sizable profit not only tried to take delivery at negative prices but also helped run the market back up out of the hole back into positive territory.
I can tell you that my phone was ringing off the wall with folks telling me they had storage available if I knew of those with oil to sell. They had leases for empty train cars, etc. One amazing entrepreneur modified storage tanks that held waste water from fracking into tanks that could hold oil. There was no need to use those tanks to hold frack water because everyone has stopped fracking. Yet they can be used to store oil, and because of the futures market, it can be done profitably.
That surge in interest in buying oil that no one wanted was because of the price discovery process. In this case, oil prices had to trade in negative territory to find the level that would make people find a way when people thought there was no way to sell or store that oil. The plunge to negative oil prices was a call to action to find demand and find storage for a commodity that had no buyers and no place to store it.
The May WTI contract’s subsequent settlement at a positive close back over $10 a barrel was a price level based on the contango and was still a profitable deal for those that found storage under the woodwork. That brought confidence to the back end of the curve and reduces the chances of a sub-zero repeat for the June futures contract expiration.
Is another way to find more storage to ban imports of Saudi oil? The Trump Administration is considering that possibility as the Saudis so far have refused to slowdown production or exports ahead of the May 1 OPEC production cuts. According to Bloomberg News, "20 very large crude carriers, known in the industry as VLCCs, that loaded since the beginning of March, each hauling about 2 million barrels each totaling 40 million barrels are headed to ports on the Gulf and West Coasts. Senator Ted Cruz, from the oil-producing state of Texas, minced no words and tweeted, “My message to the Saudis: TURN THE TANKERS THE HELL AROUND.” Many U.S. oil producers feel the same way as that believe that Saudi Arabia and Russia conspired to use unfair trade practices to put them out of business. If the tankers are forced to turnaround that will cause Brent crude to crash as that market will have to find a price level that will shake out some storage or buyers that are willing to pay for leasing the tankers until they can be offloaded.
Of course, there are still fears that we may see another sharp drop in oil prices in both Brent crude and WTI. While that’s possible, it seems less likely. If it does happen, it will cause the world to react like it did before. By then, we’ll see more production cutbacks and demand start to creep up and hopefully we’ll see the U.S. economy start its great comeback.
The EIA reports suggest that demand destruction has bottomed out. In a few months or a year will EIA will be focused on production destruction? The EIA reported U.S. crude inventories rose by 15 million barrels in the week to April 17 to 518.6 million barrels, putting them within close to the all-time record of 535 million barrels set in 2017. Yet on the product side gasoline demand rose last week. So the demand numbers and some U.S. states reopening suggest the demand destruction is at bottom.
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