U.S. Oil Costs Less Than Zero After a Sharp Monday Selloff

Source: By Ryan Dezember, Wall Street Journal • Posted: Monday, April 20, 2020

Many traders are betting that the coronavirus pandemic will run its course and demand for oil will jump later this year

U.S. oil futures plunged below $0 for the first time Monday, a chaotic demonstration that there was no place left to store all the crude that the world’s stalled economy would otherwise be using.

The price of a barrel of West Texas Intermediate crude to be delivered in May, which closed at $18.27 a barrel on Friday, ended Monday at negative $37.63. That effectively means that sellers must pay buyers to take barrels off their hands.

The historic low price reflects uncertainty about what buyers would even do with a barrel of crude in the near term. Refineries, storage facilities, pipelines and even ocean tankers have filled up rapidly since billions of people around the world began sheltering in place to slow the spread of the deadly coronavirus.

The unusually large difference in price between oil for delivery now and in the future has traders filling up tankers and setting them adrift. Photo: jean-paul pelissier/Reuters

Prices remain in positive territory for barrels to be delivered in June. In the most actively traded U.S. futures contract, crude for June delivery closed Monday at about $21, while oil due to be delivered to the main U.S. trading hub in Oklahoma in November ended at around $32.

Even before May’s price went negative, the spreads between oil now and later were records, reflecting the sharp decline in transportation-fuel demand as well as a wager that people will return to driving cars, flying on airplanes and working at factories in the months to come.

Monday’s chaotic trading was exacerbated by the looming expiration of the May futures contract on Tuesday. The price of oil futures converge with the price of actual barrels of oil as the delivery date of the contracts approach.

Though producers from Alberta, Canada to Midland, Texas are racing to shut in productive wells, they haven’t been able to close of the spigot fast enough to avoid what energy executives have been referring to as “hitting tank tops” and running out of places to store crude and petroleum products, such as gasoline and jet fuel.

The producers’ pain presents a rare opportunity for traders, who are filling up tankers with crude and setting them adrift. Their bet is that the coronavirus pandemic runs its course and later this year demand for oil—and thus its price—will jump.

“If you can find storage, you can make good money,” said Reid I’Anson, economist for market-data firm Kpler Inc.

Increasingly, traders are looking offshore. Lease rates have soared for very large crude carriers, the 2-million-barrel high-seas behemoths known as VLCCs.

The average day rate for a VLCC on a six-month contract is about $100,000, up from $29,000 a year ago, according to Jefferies analyst Randy Giveans. Yearlong contracts are about $72,500 a day, compared with $30,500 a year ago. Spot charter rates have risen sixfold, to nearly $150,000 a day.

Day rates rise as the spread between oil-futures contracts widens. The basic math is that every dollar in the six-month spread equates to an additional $10,000 a day that can be paid for a VLCC over that time without wiping out all the oil-price gains, Mr. Giveans said.

May delivery futures of Brent crude, the international benchmark typically used to price waterborne oil, ended Friday at $28.08 a barrel. The contract for November delivery settled at $37.17. The $9.09 difference wouldn’t justify a $100,000 day rate, but the record spread of $13.45 reached on March 31 does.

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At the end of March there were about 109 million barrels of oil stowed at sea, according to Kpler. By Friday it was up to 141 million barrels.

The collapse in current oil prices, combined with the expectations that a lot of economic activity will resume by autumn, has resulted in a market condition called contango—in which prices for a commodity are higher in the future than they are in the present.

 One of the great trades in modern history involved steep contango and a lot of oil tankers. In 1990, Phibro, the oil-trading arm of Salomon Brothers, loaded tankers with cheap crude just before Iraq invaded neighboring Kuwait and crude prices surged. The trade’s architect, Andy Hall, rose to fame, bought a century-old castle in Germany and became known for a $100 million payday.

Present market conditions have inspired emulators.

In the past four weeks, nearly 50 long-term contracts have been signed for VLCCs, Mr. Giveans said. Jefferies has identified more than 30 of them as being intended for storage, usually because they are leased without discharge locations. The coast of South Africa offers popular anchorage since it is relatively equidistant to markets in Asia, Europe and the Americas.

“We’ve seen more floating-storage contracts signed for 12 months in last three weeks than we’ve seen in the last three years,” Mr. Giveans said.

 Companies that own and operate pipelines and oil-storage facilities could gain as well.

Consider the difference between Friday’s prices for West Texas Intermediate to be delivered in May, which was $18.27 a barrel, and in May 2021, which closed at $35.52: A $17.25 spread could be locked in by buying contracts for oil to be delivered next month and then selling contracts for delivery a year later.

Assuming monthly costs for storage owners of 10 cents a barrel—as Bernstein Research analysts did when they ran back-of-the-envelope storage math in a recent note to clients—leaves a profit of $16.05 a barrel.

Companies don’t usually disclose unused storage capacity, but it is possible that bigger players such asEnergy TransferLP, Enterprise Products Partners LP and Plains All American Pipeline LP could have room for tens of millions of barrels, the Bernstein analysts said.

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Write to Ryan Dezember at ryan.dezember@wsj.com