Oil Floats

Something interesting about the coronavirus outbreak has been the number of “firsts” popping up. We’ve seen firsts for unemployment claim levels and for speedy stock market declines as well. We’re even in the midst of what feels like a first-time national run on toilet paper (at least since the 70’s – something about a Johnny Carson joke gone too far…). Another first in the past week has been negative prices in crude oil markets.

Last week the price of the U.S. oil benchmark, West Texas Intermediate, fell so far so fast that the price went negative, a first in modern history. As news broke of panicked selling, those of us not directly involved in the business got a reminder of how fundamental and powerful the forces of supply and demand are, the complexities of oil pricing, and how storage plays an important role.

Companies that use oil often buy it months in advance based on assumptions about business needs. During normal times, storage ebbs and flows based on supply and demand and usually finds an equilibrium. But these are far from normal times. As demand dried up because of stay-at-home orders here and around much of the world, excess oil already bought and paid for started accumulating rapidly. And as we’re all painfully aware, during this fast-moving crisis Murphy’s Law (if it can go wrong it will go wrong) applies to oil markets just like everything else.

The economic problems caused by coronavirus have left many purchasers of oil in a difficult spot. They know this situation won’t last forever and they also know they can’t simply dump the excess oil they’ve bought, like dairy farmers or pork producers are doing with their own products. Instead, they have to store it or, in some cases like last week, pay others to buy it from them, creating negative prices.

For those trying to store excess oil, the small town of Cushing, Oklahoma, is a primary location. The town of about 8,000 people is known as the “pipeline crossroads of the world” and its “tank farms” can hold approximately 91 million barrels of oil. Normally about 30% full, these are expected to reach capacity in the coming weeks.

With Cushing rapidly filling up, super tankers are floating around holding an estimated 160 million barrels of oil, about two to three times normal according to The Wall Street Journal. Companies typically rent these very large crude carriers (VLCC) for shipping and are currently paying a hefty premium to use them for storage. The ships are stationed outside major ports from Singapore to Long Beach and, presumably, will float there until demand bubbles up and prices for oil rise. The Journal also reports that each VLCC can hold about 2 million barrels and that there are enough out there to hold twice the current level. That’s a lot of oil stored very expensively. Hopefully we won’t have to find out where to store oil after that!

Meanwhile, oil prices are no longer negative, but volatility remains high. Just yesterday prices were moving downward around 25% to $13 even as the broader stock market moved higher. The price of oil is important for many reasons, just one being industry profitability. My understanding is that companies along the supply chain need oil prices to be around $30+ just to breakeven. Clearly, the oil situation is far from stabilized as people on all sides of the business are just as uncertain about the future as everyone else.

Here are two links to more information about this topic. The first is from JPMorgan and the second is a longer piece from The Wall Street Journal. The latter has a soft paywall, but hopefully you can access it because it’s an interesting read.

https://am.jpmorgan.com/us/en/asset-management/gim/adv/why-are-oil-prices-negative

https://www.wsj.com/articles/storage-crisis-worsens-for-glut-of-crude-caused-by-coronavirus-11587755805

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