April 21, 2020

Negative Prices Mark The End Of U.S. Shale

Some companies had taken on the obligation to buy a large amount of West Texas Intermediate crude oil at a certain price. The price offered by the sellers looked cheap at the time when the contracts were signed. The settlement date of the contracts was April 21.

Usually such contacts are settled in money but this time the sellers insisted on physically delivery the oil to the buyers.

That was a problem. The buyers did not have the storage capacity to accept the oil they had bought months ago. They now had to accept a large amount they could not put anywhere. The only way out was to immediately sell it to someone else. But nobody was interested. All had their storage capacity already filled to the rim. The companies with the obligation to accept the oil from the producers then offered to pay others to take their oil.

When the price started to go into negative territory I offered extra storage:

Offering to take the oil at -$50 was a bit too greedy. The WTI May option contract closed out at -$37.

For the first time in memory, US West Texas Intermediate (WTI) oil futures were trading in negative territory on the New York Mercantile Exchange (Nymex) on Monday, and US crude for May delivery lost $55.90 over the course of the trading day to close at negative $37.63/bbl. One insider said the drastic drop was in part the result of the forced liquidation of a position in the futures market “at any price.” The contract has one more day to trade as it expires Apr. 21. The May contract had an exceptionally high open interest of 109,000 contracts at the start of Monday trading. But fundamentally, the price reflects extremely distressed crude cargoes that are stranded with refineries ramping down runs, as they cannot sell products in a market where demand has collapsed from consumers who are staying home to prevent the spread of the Covid-19 pandemic. The steep negative price “means storage is full,” said Albert Helmig, CEO of consultancy Grey House and former vice president of the Nymex. Cushing is the delivery and pricing point of US oil futures and has an operational capacity of some 70 million barrels of oil. It held 55 million bbl last week.

Several large consumer countries are in lockdown. Global air travel is down by more than 80%. There is only little demand for gasoline or other refined products.

The WTI benchmark, which reflects the price in landlocked Cushing, Oklahoma, was not the only trade index in trouble. West Canadian Select oil also traded in negative territory. Contracts for WTI deliveries in June were still positive at $20/barrel as were Brent oil contracts ($25/bl) which reflect delivery at sea.

U.S. shale oil producers have already cut back some of their production but they will have to cut much more. The Baker Hughes count of active U.S. oil and gas rigs fell from more than 1,000 active rigs last year to 529 active rigs on Friday. I expect it to drop below 100 during the next few weeks.

More drilling will have to stop because the refineries simply can not sell their products:

The trainwreck in Cushing is the result of various factors coming to a head. Refiners are cutting runs faster than upstream players can shut in production, and differentials have been signaling oil to go to Cushing for weeks, even prompting some midstream operators to reverse infrastructure. In addition, market sources say that inexperienced traders hold high positions too close to expiration, and that some contracts stipulate average prices for trades ahead of expiration. When a futures trader holds a position this close to expiry, chances are high they will need to deliver physical crude. They can do so via an exchange futures for physical (EFP) arrangement, one trader said, but that requires finding a physical player willing to take delivery. This means that even under normal circumstances, there is a reconciliation between physical and futures prices close to expiry. And physical prices have been underperforming so-called paper barrels for the past several weeks, reflecting fundamental dynamics and causing that reconciliation to be abrupt and violent.

It costs about $45/bl to produce shale oil. No U.S. shale producer is currently in profitable territory. All are already highly indebted. They still hesitate to shut down their wells. Once shut down the wells tend to clog up. They will need expensive rework to be reopened. That is unlikely to be profitable during the next two to five years if ever.

The stone age did not end for a lack of stones. The oil age will not end for a lack of oil. Oil demand has probably seen its global peak. Alternatives have been developed. The pandemic will likely be with us for some two years. It will change the behavior of many people.

There is no reason to expect crude oil to ever again reach its previous peak price of more than $100/bl.

The total debt of U.S. shale oil producers is estimated to be above $200 billion. None will be paid back. The carnage may well lead to collapses in the banking system.

All countries whose budgets depend on oil sales are now in deep trouble. As they lose their importance as producers and consumers the global policies around them will also change.

The pandemic only amplifies the existing structural problems and imbalances in our markets and societies. It is likely to leave permanent marks on them.

Posted by b on April 21, 2020 at 8:01 UTC | Permalink

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