US benchmark futures prices for West Texas Intermediate (WTI) dropped to negative $37.63 a barrel before recovering yesterday, however this was due to technical factors rather than fundamentals and should be viewed as an outlier, say fund manager Fidelity
Despite Monday’s plunge being unprecedented – the first time oil has slipped into negative territory – this isn’t a sign for further bad news, according to James Trafford, analyst and portfolio manager at Fidelity.
“Is this a sign that underlying global demand for oil, or the depth of the production glut, is much worse than anyone thought? We think not. Clearly, oil fundamentals are pretty terrible. But yesterday’s price action is best understood as a quirk or peculiarity of futures trading - one that has been made much more extreme by the current situation.”
Oil futures are contracts to eventually deliver the physical commodity of a particular grade to a specific location. The oil price on screen is the paper market for future months, as the delivery date approaches, these contracts need to be rolled-over to the subsequent period.
For WTI – the oil market which turned negative yesterday - the current ‘front month’ is for delivery at Cushing, Oklahoma in May. This contract expired on April 21, and as of April 22 the ‘front month’ will be for June. Any financial player or speculator who was long the May contract and didn’t want to take delivery of a physical barrel of oil needs to sell the contract or roll it forward.
“What we saw yesterday in Monday’s selloff is that there were no buyers for WTI physical delivery in May because there is scant demand, refining runs are being cut, and storage at Cushing has already grown to more than 15 million barrels in the past month - and is expected to soon be at capacity for the first time ever,” said Trafford.
“The price movement confirms that near term demand is very weak. But it isn’t cataclysmic. We don’t see negative oil prices as a new normal going forward,” he added.