Social media went crazy the moment the news about Alberta oil going into negative hit the headlines. While this one of the rare events when a theoretical concept has come true, the doomsday stories around it are not that doomsday (yet).
Before we go into why the crude oil went into negative, we need to understand crude. All crude oils are not same — there is West Texas Intermediate (WTI), Brent, Dubai Crude, Oman Crude, Bonny Light, et al. While all these are different types of crude — in terms of quality and price, the key difference is the place where they are delivered.
Crude at the end of the day is a physical commodity that is traded on exchanges or Over-The-Counter (OTC) but delivered at a physical location (Cushing in Oaklahoma is where WTI is delivered while Brent is delivered globally at various ports). Let us discuss the top 2 types of crude and what the recent market moves tells us about it.
WTI — West Texas Intermediate is the crude that went negative on 20th April. In fact it went below -$30 at a point today while other type of crude (Brent, Bonny Light, and Dubai Crude) traded comfortably in the positive territory.
As it is clear only WTI was punished today and the real reason is the timing. While the world is in a lock-down thanks to Covid-19 and OPEC/Russia/Shale Producers in US are pumping crude at will, the real reason isn’t supply-demand as much as it is the timing of this movement.
As mentioned earlier, crude is traded on the exchanges but eventually someone has to take physical delivery of the crude. The May month contract is expiring on 21st April (Tuesday)i.e., anyone holding the paper contract as of Tuesday will have to take the delivery of the barrels in May (Each contract is 1,000 barrels and each barrel is 159 liters, i.e., 42,000 Gallons of Crude Oil)
Now comes the role of ETFs — Exchange Traded Funds that offers an option for investors to invest in crude and benefit from its movement can’t take the delivery of crude oil and they started to dump their positions for May month in the market today. This was compounded by the fact that all the storage tanks in Cushing, OK are filled and the only way to take delivery in May is to bring trucks. This led to a situation where no one wanted to take the physical deliveries however there were 100s of thousands of contract (each of 42,000 Gallons of Crude) being sold. Eventually people started to quote negative rates to cover the cost of trucks and the price went below $0. The news spread like a wild fire and soon all the contracts started to be sold at negative value and thus we reached a stage which was only possible in theory and in text books.
However, it is important to note that WTI crude price went below $0 only for the May series and not for other months. Of course Brent and other types of oil traded above $20. Important to note the June month contract actually ended up being positive for the day at $21.22 to a barrel.
With May series more or less done and dusted and a positive June series, things aren’t as bad as they may seem. Yes, the supply is threatening to flood the markets and storage capacity continues to remain full in near future. Add to this the major oil buyers (China, India, and Japan) are expected to remain in some form of lock-down for next few weeks and suddenly the picture for oil doesn’t look good.
However, it will be too early to call crude oil as a valueless commodity. A reverse of short squeeze happened today where people with long position on crude had no place to store the oil post delivery.
What happened today is historic and will be long remembered for many many decades to come. However the crude isn’t valueless yet — It is still $21 dollar for the June month and you will still be required to pay for it at your nearest gas station!
