Negative prices on near-dated WTI futures grabbed headlines yesterday. However, we should not assume from this that oil has negative value. Rather, the decline was driven by technical factors, specifically the limited storage to hold US oil. To gauge the effects of COVID-19 on oil demand more accurately, investors should look to Brent futures, which closed yesterday at $25.57 a barrel. The Energy Information Administration estimates global petroleum and liquid fuels consumption averaged 94.4 million barrels per day (b/d) in first quarter 2020, a decline of 5.6 million b/d from the same period in 2019.
The negative prices hitting our screens early this week are for the May WTI futures contract, which is due to expire tonight. Because there is very limited storage capacity in the United States, there are no buyers for the May contract, as they would have essentially nowhere to put the physical commodity upon delivery. It is rumored that refiners at both Cushing and Gulf Coast are turning away barrels and that Cushing will be at capacity by the end of May.
If we look to the June WTI contract, which will become the futures contract closest to delivery after close today, it told a different story. June WTI futures closed yesterday at $20.43 a barrel, more than $50 higher than the May contract, which closed at -$37.63 a barrel. The significant differential between May and June contracts has been called the “super contango” because of the large price buyers are willing to pay to take delivery further in the future.
The storage issue will remain exactly that, an issue, until some combination of demand rebounding and supply slowing begins to reduce inventories. The current prices of later-dated contracts suggest there is some optimism that demand will pick up modestly. On the supply side, there is reason to expect further slowdown in US production, as last week saw the largest weekly decline in active rigs since 2015, according to Baker Hughes. Given some curtailments in North America and production cuts by Saudi Arabia, Russia, and other market participants, we should start to see inventories begin to ease in July, if we see states and cities opening their economies again.
However, it is realistic to expect that until the United States reopens for business, demand is unlikely to rebound significantly, putting pressure on future contracts. While the May contract was the first to dip into negative territory, we suspect it won’t be the last. In other words, expect volatility to continue.