We have now entered the crude oil twilight zone. Never before has crude traded below zero, much less at the absurd level of negative $37.63/bbl. There is no doubt that demand for crude and motor gasoline are far below crude production volumes, leaving the market vastly oversupplied. But could it really be this bad? When you are talking about the market for physical barrels, the answer is “no”. It is bad. Really bad. But what happened yesterday had more to do with the mechanics of futures contracts and how they transition from month to month, than a complete mega-meltdown in physical barrels. That is not to say that negative prices for physical barrels are not already a fact of life in some locations. But negative $37.63/bbl? Something else must be going on. So, to put yesterday’s bizarre market action in perspective, we need to get into a few details on futures contract mechanics, and then look forward to what may be coming over the next few weeks. In today’s blog, we discuss the factors that are driving such extraordinary crude market developments.
Let’s start with what happened yesterday. The historic crash in the front-month price of WTI deep into negative territory was shocking, but some sort of collapse was not a total surprise to many players in the industry. It was a timing thing, related to the way futures contracts roll from one month to the next. The expiry of the May futures contract later today — Tuesday, April 21 — means that, as always, the spot price for WTI at Cushing will “converge with” the May futures price, and a few players with long positions (i.e., contracts to buy crude) apparently held on too long and found it excruciatingly painful to exit their positions. For the past few weeks, as U.S. refinery demand for crude was cratering and storage in Cushing and along the Gulf Coast was filling up fast, the spot price for crude had already fallen to the mid-to-low teens, well below the front-month contract. On Monday, traders still left holding futures contracts promising to buy barrels of crude for May delivery but with no place to go with the physical barrels found themselves with no one to sell to. Most of the buyers had disappeared. And the only ones left insisted on being paid to take out the positions. That meant buyers getting paid to take barrels. So the price of crude crashed to an unprecedented negative $37.63/bbl.
If you are not familiar with the way physically settled futures contracts work, futures positions that are not settled by end of close today will go to physical delivery. That means that buyers and sellers would have three days to get physical crude scheduled on a pipeline by April 25. Traders that mostly deal in paper barrels are not set up to move physical barrels and can find it necessary to pay dearly to unwind their positions as the contract month closes in on them. That’s the reason most futures positions get closed out before the last few days of trading. But yesterday, it looks like somebody waited a bit too long. And the result was a market mega-squeeze that resulted in a total blowout to the downside.
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