Free oil? Not today …

Following the news that West Texas Intermediate (WTI) Futures traded at negative prices for the first time in history last week there has been rampant social media speculation, much of it tongue in cheek, that fuel suppliers will soon be paying the consumer to take oil away but what is the reality?
Mark Waddington, Channoil Consulting looks at the fact behind the myth,

“There is no doubt that oil demand has collapsed precipitously and that fuel prices have also come down a lot with the reduction in demand. But the truth is that – even in the middle of the USA, where these negative futures prices were set – prices for physical oil products are not negative and are very unlikely to have been negative. And they certainly won’t be negative in Europe or the UK any time soon.

Mark explains why; “Firstly, the West Texas Intermediate Futures contract, or “WTI” for short, is an important global crude oil benchmark. But its price is based on market value for delivery at an inland terminal at Cushing, Oklahoma, USA. Cushing is one of the main storage hubs involved in the export of WTI. However, the world’s oil consumption has dropped by over 30% in recent weeks and the Cushing Terminal is now practically full. So, the crude oil is waiting in Cushing for a much reduced market and this is depressing the price. There is no more room in Cushing, but that does not mean that oil no longer has any value. The value of the oil in store is almost certainly already sold in the forward markets at a positive price. And anyway, Oklahoma is a long way from the UK.

It is also important to understand who uses oil futures contracts and Mark elaborates; “They are used by oil producers, who sell forward on futures market to secure a selling price for their oil production. They are also used by consumers of oil, such as refiners, airlines, trucking companies, railways, and cruise liner operators, who buy ahead on futures markets to guarantee price of the oil they are buying. And finally, they are used by investment funds and speculators in the financial sector, who want to invest in a commodity asset class.”

So, why did the prices go negative?
“It is largely a technical thing.” Mark answers. “Speculators who bought futures contracts for delivery in May found themselves holding something that no-one wanted. Therefore, they were looking to close out their financial exposure by selling back their futures contracts. Since there were no takers for these long positions the speculators were at a disadvantage and were taken out at a huge loss. The parties on the other side of the deal are most likely to be crude oil producers who had sold forward. They will have made a windfall profit on their hedges, but would still be left with physical oil, which at the  negative prices they bought back at they can afford to sell cheaply to refiners, even if they had to do it in tanker truck loads. It is unlikely that any oil has changed hands at negative prices, but it is certainly a sign of the times.”

The negative prices for WTI crude futures contracts on Monday was a market distortion that left speculators in a nightmare scenario. If anything, the oil producers will have taken extra profit from their hedging. It has no real bearing on the pump price or the delivered price of fuel, even though those prices are much lower today because of the general collapse in oil prices.

In summary:

  • The “negative oil prices” in the media, are prices for delivered futures contracts in the USA, they are not prices for physical oil, certainly not in the UK.
  • The people who sold oil futures at negative prices will be mainly funds and speculators who had no choice but to sell those futures at whatever price they could get.
  • Oil producers are very unlikely to have sold any physical oil at negative prices.

The oil industry is already absorbing much of the short-term price shock by putting oil into storage, both on land and on ships. This will cushion the worst of the price impact. But further production cuts by oil producers are going to be necessary to balance the supply and demand actuality. For consumers, prices are at recent historic lows and this may continue for some months to come.

The situation for consumers at the pump cannot be expected to reflect these low prices while the volume through the stations remains so low, as their overheads will need to be covered by a wider margin per litre sold
As a result it would be unwise to expect suppliers to deliver free of charge at any point soon.