Insight

What does negative oil price mean to investors?

what-does-negative-oil-price-mean-to-investors
US crude oil futures plunged into negative territory for the first time in history. We examine the implications.

We live in uncertain times made apparent by shocking and unprecedented swings in asset prices. 

US oil futures – as measured by the West Texas Intermediate (WTI) May 2020 contract, collapsed yesterday, falling into never before imagined negative territory of -$40/barrel during trading in the US marking and closing at -$13/barrel in the biggest single-day decline on record. This means that producers were essentially paying buyers to take physical delivery. 

Although COVID may have originally kickstarted the monthlong volatility in oil prices, the oil supply spat between OPEC members, led by Saudi Arabia, and Russia sent oil prices in a tailspin. A recent deal between OPEC and Russia to cut nearly 10 million barrels a day of oil supply in May and June has done little to an already rattled market. 

Physical barrels are having difficulty finding buyers due to storage constraints and are now being sold at distressed prices.  

US producers over the years have been pumping out copious amounts of oil due to new fracking technologies and the US has turned into a net energy exporter. Producers will accept negative prices so long as that is cheaper than the cost of closing down and reopening production. 

Collapse in demand caused by COVID-19 lockdown – a major concern 

Stepping back, yesterday’s WTI move is a technical aberration and does not truly reflect what’s going on in the commodities world. The -$13/barrel is the contract price of May delivery that oil traders have fled from. Whereas the price for delivery in June 2020 is $20/barrel and for June 2021 it is $35/barrel.  

Meanwhile the active June 2020 Brent crude contract, a better indicator of global oil prices, was down only -3% at $25.49/barrel. Although Brent may not have reacted to the same extent as WTI, the direction is still the same.
   
That being said, the recent volatile oil price movements are due to both supply and demand factors.  

It’s important to remember that the recently announced OPEC supply cuts are around the corner next month and we can expect eventual US shale producers to also cut supply. Producers have seen supply/demand cycles before and will adjust supply accordingly. 

The market is also now fully aware of the storage capacity constraints. The bigger more systemic problem I worry about is on the demand side – due to the economic recession caused by the COVID-19 lockdown.  
 

David Chao is Global Market Strategist (Asia ex-Japan) at Invesco.