As oil inventories reach record levels, commodities experts and exchanges are preparing for the unimaginable
The past several weeks have been agonizing for the oil industry as the pain of massive demand erosion was compounded in March by a production feud between Saudi Arabia and Russia. That conflict was resolved over the weekend as leading oil producers agreed to a coordinated output cut — but even that might not be enough to prevent an unthinkable scenario in some areas.
“While U.S. crude futures have shed half of their value this year, prices for actual barrels of oil in some places have fallen even further,” reported the Wall Street Journal. “[P]roducers could soon be forced to pay consumers to take it off their hands—effectively pushing prices below zero.”
Part of the problem, as noted by the Journal, is that the industry’s capacity to store excess oil is limited. Amid virtual shutdowns of factories and transportation systems around the world, refineries have dramatically reduced their activity, leading to a rapid buildup of crude stores.
Data from the Energy Information Administration show U.S. crude inventories spike by 15.2 million barrels during the week ended April 3, and gasoline stockpiles leaped by 10.5 million barrels. Refining activity, meanwhile, has sunk to its lowest level since September 2008.
Some areas are able to partly address the supply glut problem because they can turn to tanker ships as a storage option. But according to Jeffrey Currie, head of commodities research at Goldman Sachs, other areas might have to deal with the excess by going to extremes, such as paying to have it taken off their hands.
Physical traders are watching the market with bated breath as some regional crude prices test critical levels. S&P Global Platts assessed that the spot price of Western Canadian Select at Hardisty descended to just north of US$8 per barrel on April 1, while the spot price of West Texas Intermediate at Midland fell to just above US$10 a barrel on March 30. Wyoming Asphalt Sour crude recently fetched a bid of less than zero dollars from one commodities trading house, reported the Journal.
Some traders of energy derivatives are also bracing for the possibility of negative pricing. “It’s something we have to consider,” Mark Benigno, co-director of energy trading at INTL FCStone, told the publication. “Options are structured to go to zero. … When they go below that, it becomes a different situation entirely.”
CME Group, recognized as the world’s largest exchange by market capitalization for trading futures and options, has said it is preparing to process negative prices for energy-related financial instruments by reprogramming its software.
In recent weeks, traders have been hoping that an agreement between OPEC and other oil-producing nations would spur a rebound. But some have argued that problems in demand are far too severe.
“[The supply cuts are] not nearly enough to make a significant shift in balancing the market,” Chris Midgley, global head of S&P Global Platts Analytics, told the Journal.
