After plunging below $0 on Monday as the May futures contracts neared expiration, West Texas Intermediate continued its descent with the price of oil on the June futures falling to $10 a barrel.
The problem, clearly, isn’t in just a technical glitch in the futures market but in the fundamental mismatch of supply and demand and fears of an exhaustion of all global storage.
The plunge yesterday in the price of the expiring May futures was driven by this lack of storage. Traders were desperate to sell the May future before it expired because they didn’t want to have to take delivery of physical oil. They had no place to put it.
But since no one had any storage, no one was buying the May futures no matter the price. The situation was made even worse by the structure of the U.S. Oil Fund (USO), which is a paper vehicle that cannot take delivery of oil. The ETF had rolled over most of its May futures into the June futures that expire in mid-May. With so much of the cash flowing into the oil markets coming through the U.S. Oil vehicle the resulted in even fewer potential buyers.
Today’s drop in the price of oil on the June future comes on fear of a repeat of the May futures/no storage problem in June. OPEC’s newest agreement to cut production doesn’t go into effect until May 1 and it will only removed 10 million barrels a day in oil supply when oil analysts estimate that the coronavirus recession has destroyed global demand for 35 million of barrels of oil a day.
U.S. oil shale producers, some of them anyway, are cutting production but their willingness/ability to cut production is severely limited by their needs for cash flow to pay their own bills, and especially to pay interest on their debts. At some point, these companies will have to cut production because prices will be so low and storage so nonexistent that they don’t have any choice. In economic theory, a decline in price provokes a decline in supply. In reality, though, that response can include substantial delays and occur in bumpy stages rather than in a smooth curve. Government regulators have relatively little control over the production decisions of U.S. producers and so far the body with the most control, the Texas Railroad Commission has not acted. The commission in fact put off any action at today’s meeting.
The short term problem has gotten even worse as the individual investors who own the bulk of U.S. Oil Fund shares have been selling. That has driven the fund’s share price lower to $2.535 as of 1 p.m. New York time today. That’s a drop of another 32.8% and I’m sure it will lead to more selling. That forces managers of the U.S. Oil Fund to do more selling too. And that pushes the price of oil futures lower.
What ends or at least stabilizes this plunge? There’s no evidence of some hidden storage capacity. Royal Vopak NV, the world’s biggest independent storage company, has said almost all of its storage space is sold. This week’s report on U.S. oil inventories and storage at the Cushin, Oklahoma hub from the U.S. Energy Information Administration is likely to paint a dark picture. That could make the next few days of trading in oil markets this week just as chaotic.
Further out, the U.S. government has said that it will expand storage in the national strategic oil reserve. There’s talk of plans to pay oil companies not to put oil on the market by providing government (that’s shorthand for taxpayer) cash to cap wells and to transfer ownership of oil in the ground to Washington. Some program of debt relief for stressed oil shale producers is also under discussion at the White House. Saudi Arabia, Russia, and the other members of OPEC+ have begun discussing another round of production cuts.
The talk, if it gets loud enough, might stabilize the market for a bit. The Trump administration seems to mean it when it says that it will do something for the oil industry.
But clearly this is going to take a while since oil demand doesn’t look like it will snap back quickly anywhere in a coronavirus world.