What is happening in the oil market?

02/05/2020

Last 20th April, the world witnessed WTI trading at negative prices for the first time. That day the oil price fell more than 300%, reaching -35$/barrel. It means that people buying WTI got paid 35$ per barrel. How was that possible? I am going to explain it:

First of all, some essential concepts. Regarding the oil market, there are two types of oil (WTI in America, Brent for the rest of the world) and also two types of rates, the future’s contract price and the spot price. Futures contract negotiates the oil price in each of the months. On the contrary, the spot price is how much do you pay for the barrel today. 

Both prices are usually quite similar. However, when there is a significant difference between the next’s month contract price and the spot price, it is called Contango. This is what happened in April. 

Due to the COVID-19, the demand for oil fell sharply (around 23%). In February, OPEC countries did not agree to cut the production and even Russia, and Saudi started to pump up more oil to gain market share, making the oil prices collapse from around $60 to $25. (Brent usually trades some dollars up to WTI due to its higher quality). The result was an oversupply in the markets, and consequently, the storages started to fill up. 

In March OPEC+ plus the US and Canada agreed on production cuts (9.7 Million barrels/day OPEC+ plus 6/7 the US and Canada), starting on 1st May.

The main problem was that during April, oil producers continued producing oil at the standard rate, even having a 23% fell in demand. It made storage full, and they have no place to put the oil.

The first thought is, well, why did they not stop production? To make it simpler, let’s say that because of the oil volatility, oil producers reach agreements with banks to receive a fixed amount of money per barrel in case that the oil price falls more than that level. So, if American companies (which produce around 12% of the global demand) continue getting paid at a normal price, there is no reason to stop pumping oil.

On 20th April, the day before the future contract for May expired(once expire you have to pay that price and get the barrels), traders had no place to keep that oil. Consequently, they preferred to offer themselves to pay for the oil to others instead of having the legal requirement of keeping that for themselves. Meanwhile, the contract for June was traded around $20 because people have the hope that due to the reduction in May’s production, there will be some space to keep the oil and the price will be higher than 0.

As a result of the lack of storage, a vast number of tankers (vessels) is being used as floating storage. Traders prefer to rent the vessels to storage the oil, hoping for a price recuperation in the coming months. As people were receiving up to 35$ for having oil, they used that money to rent the tankers and wait for the oil recuperation.

Regarding the coming months, it is expected a recuperation in oil demand. Moreover, as the OPEC+ & US & Canada production cuts will last up two years. We could see the oil price reaching 30-40$ at the end of the year. Meanwhile, the main winners of this situation are the oil tanker companies. As it is Teekay (NYSE: TK), which will analyse in the coming days.