In last week's Market Digest we referenced the massive shortages of toilet paper and hand sanitizer brought on by the coronavirus pandemic. But elsewhere in the economy, we're dealing with a massive glut: oil.
The oil industry has so much extra oil, it doesn't know where to put it and for the first time ever, the price of oil, as measured by West Texas Intermediate, fell below zero on Monday. Some traders actually had to pay buyers to take oil off their hands.
At the beginning of the year, WTI traded around $60/barrel, but as the coronavirus pandemic led to unprecedented loss of demand, prices began falling. On Friday, WTI had dropped to around $18/barrel. But on Monday, prices for May delivery plummeted through the floor and settled at -$37.63. Those contracts for May delivery meant traders needed a buyer who was capable of receiving oil at a time when most of the country remains on lockdown. Because demand has dropped so significantly, those buyers must also be willing and able to store the oil. However, storage facilities, refineries, pipelines and even ocean tankers have quickly filled up since billions of people around the world began sheltering in place. Prices are reflecting the fact that there's simply no place to put the oil.
Although current oil prices have collapsed, there are expectations that once the healthcare crisis is under control, economic activity, and a corresponding demand for oil, will resume as early as this fall. That has resulted in higher prices for barrels that will deliver further into the future. Currently contracts for WTI delivery in May of 2021 are trading around $35/barrel. This condition—in which prices for a commodity are higher in the future than they are in the present
is called contango. Clever traders have been buying up oil at impossibly cheap prices in hopes of selling those contracts in the future for a handsome profit. Those traders are stashing the oil wherever they can. An analyst at Jefferies noted, “We’ve seen more floating-storage contracts signed for 12 months in last three weeks than we’ve seen in the last three years.” Those of us along the California coast can see the stalled ships. As of today, there are roughly 20 million barrels of oil (enough to satisfy 20% of the world's daily demand) floating off the West Coast between Long Beach and San Francisco.
This week it was painfully clear: oil demand fell so quickly and so unexpectedly, that oil supply couldn't adjust fast enough. The historic drop in prices came just as production was reaching new highs and commodity traders have exacerbated the problem by making bets that prices will rise dramatically in the coming months. Now the infrastructure has been overwhelmed and the oil industry is in crisis. Equity traders took notice. US stocks have fallen sharply this week as traders are understandably concerned that the deep losses in the energy industry will further impact the US economy.