Plunge of US crude prices into negative territory unlikely to be the new normal

THE world stood aghast on Monday night following the historic crash of US crude prices.

The spectacular fall was prompted by battered oil demand in the wake of widespread shutdowns to contain the Covid-19 outbreak and fears that US storage facilities were hitting the brim.

West Texas Intermediate (WTI)'s May futures contract plumbed to a stunning minus-US$37.63 a barrel as traders bailed on the front-month contract to roll over their long positions ahead of Tuesday's expiry. It hit an extraordinary bottom of minus-US$40.32 a barrel at one point. Amid the outbreak-led demand shock, the oil market moved into a super contango where crude prices for future delivery were markedly higher than spot.

In short, due to weak demand, there were no buyers while no one wanted to take physical delivery of US oil in the short term and contend with - among other things - additional transportation and storage costs. There is a record 160 million barrels of oil stored on container ships around the world while US storage facilities are expected to hit capacity for the first time.

Based on the trajectory of crude prices, the Chicago Mercantile Exchange (CME) provided a special dispensation on Monday for crude to swing into negative territory. If prices had not been allowed to turn negative, it would have triggered serious physical delivery problems upon expiry.

But while the fallout in US crude signals an acute situation in unusual times, the bizarre drop was triggered by a technical quirk in the futures market ahead of the May contract's expiry on April 21. In other words, it is very unlikely that negative oil prices will become a new normal.

The return of some semblance of sanity to crude prices is proof of that. Lending some support to crude prices are remarks by US President Donald Trump that his administration will look at a proposal to block Saudi Arabian oil shipments to the US.

Another factor that lends credence to views that Monday's sharp crash was an outlier is that except for WTI's May contract, it was not "all hell breaks loose" elsewhere.

For one thing, WTI's June contract fell 12 per cent and is trading around US$20-21 a barrel. And unlike the US-centric WTI, prices of Brent - the international benchmark that is less tied to US consumption - did not suffer a price shock and is still around US$23 a barrel. One reason for that, analysts say, is that international storage is more readily available than US storage - at this point at least. Dubai crude futures, which are used more as a benchmark for Asian downstream players, is at around US$21 a barrel.

Even so, the gloomy fundamental theme appears intact as Covid-19 continues to wreak havoc on the world and by extension, energy demand.

The recently-agreed supply cuts by the Organization of the Petroleum Exporting Countries (Opec) and allies are disappointing. Never mind that they have come late after the Saudi-Russia price war whacked the commodity, but they are insufficient to rebalance the market.

Another big worry looms: If traders were unable to access US storage for crude delivery in May due to a supply glut, how much can possibly change in June? In the absence of a significant recovery in demand, negative prices could return for June. If that happens, the world may be less stunned, but should be no less worried.