Negative WTI Oil Prices: Oversupply and Weakened Demand in the COVID-19 Pandemic

On April 20th 2020 — a day often reserved for getting highs, WTI oil prices hit an unprecedented low.

The WTI May futures contracts slipped into the negatives as they approached expiry. When something trades at a negative price, this essentially means you get paid to “buy” it. It’s a loss to the seller and a gain to the buyer, who is given money just to take ownership of the asset.

In the midst of already dismal oil prices due to the Saudi-Russia oil price war and heightened oil production, the impact of the COVID-19 lockdown measures means the regular demand for oil globally is no longer present. With airlines completely grounded and people staying at home, global demand has been weakened to levels not seen before.

However, a sudden shock to demand doesn’t easily and quickly correspond to a sudden halt in supply. US oil producers (to whom WTI is the benchmark oil price of) are now faced with a temporary supply glut and are running low on storage for the excess oil.

The oversupply is now threatening to overwhelm the available storage capacity at Cushing, Oklahoma, the delivery supply hub for Nymex futures. This means producers now have to give away their oil for free or even pay buyers to take the oil off their hands since they have a limited capacity to store the oil themselves.

As it turns out, dumping the oil into the ocean may produce a much less favourable response than paying people to take it off your hands.

The alternative is to halt production at the wells, which would hurt producers even more than paying buyers to take the excess oil for a temporary period.

Since the storage problem is in the US, WTI prices are negative while Brent oil prices have held steady.

It’s worth noting that negative oil prices are not an ominous portent of doom. Context is important. On a regular sunshiney day it would spell disaster, but an unprecedented abnormal reaction to unprecedented abnormal conditions is in fact, part of the new normal.

We witnessed this similar mismatch of supply and demand with farmers and their crops. Farmers across the globe were forced to give away crops for free or destroy them because of the sudden disruption in demand under the COVID-19 lockdown.

Oversupply isn’t a problem limited to the oil industry. In 2018, Germany essentially paid consumers to use electricity because the supply from renewable energy outstripped the demand, and there was no place to store the excess energy.

Mismatches in supply and demand equilibrium exists even outside of a pandemic, albeit the pandemic exacerbates the problem exponentially.

Market Dispersion

What about the stock market reaction to the negative oil prices? In the new normal under the pandemic, we see big swings and limit down circuit breakers halting trading. 5% up or down in the market in one day is part of the new normal. However the S&P 500 dipped less than 2% on April 4th 2020 with historically low oil prices.

This dispersion between oil prices and stock prices is best accounted for by the fact that traders and investors view the negative prices as a historic, one-off event, unlikely to be sustained in the market and unlikely to be repeated for the WTI June futures when producers adjust their supply and storage levels.

We’ve also witnessed far more absurd pricing — as with negative yielding junk bonds, which is the equivalent of paying someone to borrow your money when you know you’ll probably never get it back.

The new normal is crazy, but it’s temporary. Nothing lasts forever, not even a global pandemic.

Nevertheless, expect historic volatility to continue until the virus is contained.