Negative oil prices!

20 April 2020

We have been experiencing strange things on the oil markets since the onset of the corona crisis. First the Saudis felt the need to increase production and sent oil prices plummeting. But today in the USA the total crash: minus 38 USD for a barrel of oil. The most important raw material in the world costs nothing more, no, you get money if you buy it. This development has completely thrown many a market observer off his game.

As always, when surprising things happen on markets, market participants expect explanations. Business journalists report eagerly and quickly and thus help their readers to classify important developments. This was also the case on this memorable day, when WTI (light US oil) prices fell from plus USD 20 to minus USD 38 within hours. As always, the question asked by the media is: Why?

In the Süddeutsche there is already an explanatory article at 21.17h. In it a steep thesis is put forward:

"In plain language: Oil producers had to pay for someone to buy the greasy raw material from them at all."

Obviously, when prices were falling, supply dominated demand. And supply, that's the producers, isn't it? But here the author is wrong. Let's take a look at the market positioning in the WTI future contract. For delivery in May, prices collapsed today. On NYMEX, the non-commercials, i.e. not the producers but consumers and speculators, were long invested with 511,000 contracts, i.e. positioned for rising prices. Their long position has now gone into imbalance.

When the futures expires in May, these speculators would have to buy huge quantities of oil, for which there are no buyers in the real economy. The only solution is to roll the contract into the next future contract. But who wants to have the oil delivered instead, if there is currently far too little oil being consumed due to Corona? You would have to store it. Only where, when the storage facilities are full? In the past, this could be done partly on tankers, but some of them are no longer in operation.

The problem, dear author, is not the producers! They are short and have already sold the oil on a forward basis earlier. This gives them the right to sell them to the speculators at a fixed price. The speculators have the problem, they have a purchase obligation.

In my opinion, the only solution to the dilemma at present is to close the wells as quickly as possible. This would enable the producers to "relieve" the speculators by allowing them to buy back the contracts for a negative price (!). Perhaps this is also the reason why the shares of oil producers in the USA today lose comparatively little.

In fact, the number of active wells has already fallen from around 800 on March 13 to the current 529 - and at record speed. However, this figure is probably still too high. In the last oil crash low in 2016, only around 400 wells were still active in the USA.

The article goes on to say: "What is striking, however, is that the American WTI oil price is falling much more sharply these days than the price of its sister variety, Brent oil, which is setting the tone in Europe in particular.

Not a word now about the fact that WTI can essentially only be refined in the United States. Brent, on the other hand, like Saudi heavy oil, can be processed almost anywhere in the world. Moreover, there is less, much less speculation in Brent! Here, speculators are currently only long with around 67,000 contracts, one of the lowest readings (!) since 2011. Instead, the author quotes an oil expert who makes no mention of the market conditions on the futures markets.

In days like these, investors should always remember that the price of oil and the value of oil are not the same. At best, the market has correctly valued the value of an oil short position today. Just as VW was not the most valuable company in the world in 2008, when an out-of-control speculation in VW options shot the price up to 1,000 Euros, the "value" of oil can never be negative. The price just does.

But on a day like today, which will go down in financial history, that doesn't really matter.