Breakingviews - Oil’s big crash is more rational than it looks

Oil pump jacks work at sunset near Midland, Texas, U.S., August 21, 2019. REUTERS/Jessica Lutz

LONDON (Reuters Breakingviews) - Oil prices have gone through the floor, literally. The price of a barrel of West Texas Intermediate crude oil went negative for the first time in history on Monday as traders panicked that storage for black gold coming from the vast U.S. fields had filled to the brim. Normally, that sort of crash in one-month U.S. crude futures would be indicative of something funny going on in the market rather than something deeply disturbing. In this case, both things can be true.

The immediate cause of the mayhem was the normally innocuous news that the so-called “front-month” contract for May is expiring on Tuesday. Usually, investors who want to continue to invest in oil would simply sell their soon-to-expire paper to buyers that want it right now, and then buy the June contract, with a minimal price difference between the two.

Yet with the June contract still trading at $20 a barrel, that spread is now at an unprecedented level. Plummeting demand and a lack of restraint from U.S. drillers mean that at the current rate, storage capacity in Oklahoma will be full in a few weeks, traders told Reuters. Buyers are so wary of taking delivery of crude amid what they see as a global oil glut and a storage crunch that they will only do so at murderously low prices.

The optimist’s view, if such a thing is possible, is that other oil benchmarks are less bombed out, and dislocations like this could also suggest short-term investors are struggling with their trades. The similar contract for Brent crude, which reflects oil prices in Europe, fell “only” 9% to $25 a barrel on Monday. Recent cuts led by Saudi Arabia and Russia in theory offer a coordinated reduction that will remove 10 million barrels of oil from the market daily in May and June.

Critically, though, these cuts don’t start until next month. A large chunk of the promised cuts may not even materialise, and pressure on Texas regulators to limit production hasn’t transpired, suggesting there’s no regional relief in sight either.

The basic problem remains that the hit to daily global oil demand from Covid-19 could be as high as 30 million barrels. If so, storage will be busted through, and prices will need to fall low enough for the market to balance. While Monday’s epic crash may represent an overshoot, it is based in reality.


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