Into uncharted waters and a return to basics

As the UK drags itself through the sixth week of social distancing, history was made on 20 April 2020. On Monday evening, the value of a barrel of West Texas Intermediate (WTI) oil, or Texas Light Sweet, declined to an unprecedented MINUS $40.32. It was the blackest of days for black gold, says Chris Beasley.

Among the questions energy professionals will be pondering are:

• how can a commodity turn negative?; 

• what does this mean?; 

• will Brent follow WTI lead?; and

• what can we expect from WTI pricing?

First of all, what is West Texan Intermediate? WTI is the US mainland Crude Oil Index, produced largely as the name would suggest in the Midwest oil fields and Texas. WTI is largely comparable for US pricing to the International benchmark of Brent, based out of London. WTI is a sweet or a light crude meaning that WTI has a relatively lower sulphur content. On the whole, when refined WTI produces high yields of gasoline and diesel – the most desirable refined products. 

How can a commodity turn negative? The short answer - supply and demand. There isn’t enough storage for the product.

Due to the global Covid-19 Pandemic and the myriad of social distancing and lockdown measures deployed we have seen global demand for fuel, be that road, shipping or air freight, evaporate. 

As US domestic and international demand has dramatically contracted, the world has been awash with cheap, relatively high-grade crude oil. This is largely due to the OPEC+’s increase in production, a product of the Saudi-Russian relations and the Saudis repositioning as discount exports.

Due to shale revolution (new drilling methods rendering previously uneconomically fields viable) and the Trump administration’s energy policy over the last few years the US has become a net energy exporter. US crude producers haven’t been able to reduce supply into an already saturated market in time. Unwanted crude will need to be put into storage. 

The American storage hub, Cushing, Oklahoma – a small town of only 10,000 people, has filled unexpectedly quickly. Storage in Cushing is 70 per cent full as of last week and it is anticipated to be full within two weeks. The lack of readily available storage means that producers are paying buyers to take produce off their hands, thus turning the price negative. 

Will Brent follow WTI? At the time of writing, no. This is what some analysts and traders would call a perfect storm, but largely for the American WTI. The UK is still a net energy importer. Forties, the main UK Crude pipeline does not produce for the UK domestic needs. Globally, demand is weak but net global storage is unlikely to be filled in a short period, so it is unlikely that Brent, the international index will follow the US-centric WTI. Although this presents a fantastic arbitrage opportunity for traders.

In the short term, we could see a continued fall in WTI pricing. In the longer term, Wall Street investors have begun to call time on shale investment. Without capital there is likely to be a fairly steep decrease in oil rig count resulting in reduced production. With the anticipated bloom of economic activity coming out of the Covid-19 Crisis one would expect the demand for oil products to return. 

Chris Beasley is risk and market analystat ZTP (www.ztpuk.com), an energy management and software specialist.

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