Oil prices plunged on Monday as traders got caught in a desperate race to offload contracts for just about any price they could get.

The price of a contract to deliver West Texas Intermediate crude oil next month plunged below zero, as traders got caught in flurry to sell their contracts before having to actually receive the oil.

The oil price is determined through investments known as futures contracts, which are agreements to buy and sell a certain amount of oil at a certain time in the future. The contract to deliver oil in May has been the most commonly traded contract of late, so it is currently considered to be the best proxy for the current oil price. Soon June’s contract will be the benchmark.

Typically the contracts are bought and sold countless times before the oil is actually delivered to the final buyer. But the May contract is set to finalize on Tuesday, which means anyone holding contract at that point is agreeing to actually physically acquire the oil.

That’s easier said than done lately, as storage tanks in North America are almost full to the brim, making it hard to find a place to put more oil. The U.S. oil hub in Cushing, Okla., had 55 million barrels of oil in storage as of Friday, the highest level since 2018.

Monday’s startling oil price plunge was caused by traders feverishly trying to offload the contract before they actually have to find a place to keep the oil starting next month. When the futures market closed for the day, the May WTI contract sat at -$37.63. If that price holds until the end of Tuesday, it means anyone holding that contract will have to pay more than $37 for the right to also hand over a barrel of oil in May.

“This may prove to be one of the worst deliveries in history,” said Phil Flynn, senior market analyst at Price Futures Group in Chicago. “Nobody wants or is in need of oil right now.”

CME, which runs the market on which oil futures contracts are traded, clarified just last week that negative prices were theoretically possible, even though they had never happened in oil. “Support for zero or negative futures … is standard throughout CME systems,” the CME said.

While jarring, the oil price plunging into negative territory doesn’t functionally mean that oil companies are en masse having to pay people to take away their product.

Rather, it means investors who created financial instruments to bet on the price of oil are having to pay hefty penalties to extricate themselves from trades they no longer want to be in.

Rory Johnson, managing director and market economist at Price Street, says the plunging future price is more like a “hot potato” being passed around between traders.

Whoever gets stuck with the hot potato “will be stuck with thousand of barrels of physical oil and no where to put it, which will get expensive very quickly,” he said.

David Winans, principal at PGIM, said the unprecedented price plunge “feels like oil is passing a kidney stone, a very painful move, but it can’t last for long, since producers are switching off wells as we speak,” he told Reuters.

Storage on land is filling up everywhere, so some producers have taken to storing their excess oil at sea, renting tankers to float aimlessly to store the crude until a higher price or buyer can be found. Rates for the biggest oil tankers have soared as producers scramble to secure space to keep the crude they don’t know what else to do with.

“Floating storage remains the only outlet for a mismatched production and consumption backdrop,” Evercore shipping analyst Jonathan Chappell said in a note to clients last week.

The going rate for the biggest oil tankers in the world hit $165,000 a day this weekend, Chappell calculates, but despite that up-front cost, “it is difficult to envision a scenario where floating storage is not economic and required over the coming months.”

June’s oil contract is also lower, but nowhere near as much. Late in the day on Monday, the June contract was changing hands at $22.27 a barrel, down almost $3 on the day.

While May’s plummet is excessive because of an unexpected imbalance, the intrinsic value of oil is indeed falling because there is too much supply and not enough demand for it.

The COVID-19 pandemic has walloped the global economy, as lockdowns, travel bans and factory shutdowns reduce the need for energy. Oil analyst Bjarne Schieldrop with SEB Research says global demand for oil has fallen by about 25 million barrels a day because of the pandemic.

The oil cartel known as OPEC tried to address that earlier this month by promising to pump 10 million fewer barrels of oil every day, but even that huge supply cut isn’t enough to offset the corresponding drop in demand.

“If your bathtub is about to overflow and you turn down the tap a little, it will still overflow,” Schieldrop said.

‘Negative prices are possible’

The type of oil that comes from Canada’s oilsands is known as Western Canadian Select and it, too, has seen its price plunge in the current economic climate.

WCS typically trades at a discount to WTI since it is harder to transport and refine, and the sell off in WTI’s price has pushed the price of WCS functionally below zero, too.

Raymond James analyst Jeremy McCrea told CBC News in an interview that he expects the price of WCS will continue to flirt with going below $0 for a little while yet.

“We did see WCS go negative this morning,” he said in an interview. “As we look forward into the next month it does seem to get a little bit better but with storage so full and getting more full by the day it doesn’t look too optimistic over the next couple months.”

Schieldrop says faced with these prices, many producers will have to stop pumping — possibly forever.

“The oil price is now ordering producers to halt production and it is happening at high speed and in an unorderly fashion,
 he said. “This is creating damage to production and some of it will never come back online again.”

Hedge fund executive Pierre Andurand of Andurand Capital said negative prices make sense in the current climate. 

“There is no limit to the downside to prices when inventories and pipelines are full,” he tweeted. “Negative prices are possible.”

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