An oil derrick pumps crude from the ground near Luling, Texas on April 20, the day when benchmark US WTI oil future prices turned negative for the first time. (Photo by Dave Creaney/Anadolu Agency via Getty Images)
Monday’s plunge in oil prices was both fascinating and unprecedented. US benchmark futures prices for West Texas Intermediate (WTI) dropped to negative $37.63 a barrel before recovering. Is this a sign that underlying global demand for oil, or the depth of the production glut, is much worse than anyone thought?
We think not. Clearly, oil fundamentals are pretty terrible. But yesterday’s price action is best understood as a quirk or peculiarity of futures trading - one that has been made much more extreme by the current situation. Here’s what’s going on:
- First, remember that oil futures are contracts to eventually deliver the physical commodity of a particular grade to a specific location. When we look at the prices on a financial data provider like Bloomberg or Reuters we are seeing the paper market for future months (delivery for next month, or in six months, etc.). As the delivery date approaches, these contracts need to be rolled-over to the subsequent period.
-For WTI, the current ‘front month’ is for delivery at Cushing, Oklahoma in May. But this contract expires April 21, and as of April 22 the new ‘front month’ will be for June. Any financial player or speculator who has been long the current May contract and doesn’t want to take delivery of a physical barrel of oil needs to sell the contract or roll it forward.
- What we saw yesterday in Monday’s selloff is that there were no buyers for WTI physical delivery in May because there is scant demand, refining runs are being cut, and storage at Cushing has already grown to more than 15 million barrels in the past month - and is expected to soon be at capacity for the first time ever.