Why oil prices fell into negative territory — and why it might happen again

Why oil prices fell into negative territory — and why it might happen again
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Oil prices rose back into profit Tuesday after dipping into negative territory for the first time in history on Monday. But the rebound may be short lived as a lack of storage space could push markets to a similar crash within the next month. 

Benchmark West Texas Intermediate settled at around $10 Tuesday, a significant uptick after trading at around $3 for much of the day and dipping as low as negative $16, but still a far cry from price points in the $20 range seen for much of March.

Overall market conditions, however, have changed little since prices fell as low as negative $40 Monday. The negative prices were caused by a drastic 30 percent cut in the demand for fuel that left companies effectively paying others to store their crude.

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With demand at historic lows for the immediate future, a second wave of negative pricing could be seen again.

“It does speak to this fear around storage and the lack of demand that's facing the market right now,” said Christopher Page, a market analyst with Rystad Energy. “There’s a high chance U.S. onshore storage could be full again, so it’s why prices are recovering that much.”

Part of what fueled negative pricing is the contract basis on which oil is purchased. Traders had until Tuesday to buy and sell contracts for May, leaving those in financial markets at risk of having to take physical possession of thousands of barrels of oil.

“Once the month rolls, if you haven’t closed out your positions, you’re expected to go to delivery, and if you’re not involved in the physical market and have no means to make or take delivery, you’re caught at whim of those who trade in both the physical and financial markets, and that’s what caused the negative pricing,” said David Braziel, president of RBN Energy.

The U.S. is quite literally running out of places to keep oil. Some oil companies have stored oil in rail cars, others in tankers at sea. One firm has suggested storing oil in bags. Rystad Energy estimates there may be only 21 million barrels’ worth of free storage left.

“The idea of negative pricing even when I raised it a month ago, people thought it was crazy, but we saw the size of the surplus and the lack of storage,” Jim Burkhard, vice president and head of oil markets at IHS Markit, told The Hill. 

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“Fear and desperation is what drives prices in these circumstances.”

Some traders try to take advantage of the hectic few days before the end of the monthly contract period, leaving just a couple thousand oil contracts trading on the market compared to the more than a million normally traded.

“There are those who try to play that volatility and obviously yesterday they got whacked,” Braziel said.

Trading on June oil contracts settled at $11.57 a barrel Tuesday, down from around $20 on Monday — a sign that market conditions in the summer don’t appear much more favorable. Similar trading practices on June contracts could once again spur negative prices.

“It's the same dynamic. It's this massive surplus that is going to haunt the second quarter of this year,” Burkhard said. 

But traders hit with low prices may have learned some lessons. 

“If you’re having to pay $38 to get someone to take it away, that's a pretty strong incentive to not be left holding oil,” Page said. “News yesterday of negative prices has caused a lot of traders to probably get a lot more scared about buying these contracts because no one wants to be left holding the barrel.”

Lawmakers are weighing further interventions to help stabilize the market.

President TrumpDonald John TrumpSessions accepts 'Fox News Sunday' invitation to debate, Tuberville declines Priest among those police cleared from St. John's Church patio for Trump visit Trump criticizes CNN on split-screen audio of Rose Garden address, protesters clashing with police MORE on Tuesday floated funneling cash to the oil and gas industry to help keep them afloat.

“We will never let the great U.S. Oil & Gas Industry down,” Trump tweeted. “I have instructed the Secretary of Energy and Secretary of the Treasury to formulate a plan which will make funds available so that these very important companies and jobs will be secured long into the future.”

The Trump administration has already begun to rent 23 million barrels of space in the nation’s emergency fuel storage to oil companies, and there has been a push from mainly Republican lawmakers to ensure oil companies have access to stimulus funding. 

Republican lawmakers spoke with Energy Secretary Dan Brouillette about next steps Tuesday morning. 

“From working with our oil producing allies in North America, to filling up the Strategic Petroleum Reserve, and to ensuring that oil and gas producers have access to the Fed lending facilities created in the CARES Act, the Secretary reaffirmed that all options remain on the table and that President Trump is committed to solving this problem,” according to a statement from House Minority Whip Steve ScaliseStephen (Steve) Joseph ScaliseTop GOP lawmakers invite Blue Dogs to meet with China Task Force Top GOP lawmakers invite Blue Dogs to meet with China Task Force over coronavirus probe House pays tribute to late Congressman Sam Johnson on the floor MORE’s (R-La.) office. 

Such a move would almost certainly be opposed by Democrats, who have already penned various letters opposing any stimulus funding for oil companies. 

There have also been calls to hold another meeting of OPEC+, a coalition of oil producing countries beyond the initial Organization of Petroleum Exporting Countries membership.

That group recently agreed to cut oil production by 9.7 million barrels per day, a 10 percent drop in global production, but those cuts aren’t scheduled to begin until May.  

But it’s not clear that any government measures would be enough to offset the glut of oil already crowding the market as demand remains extremely low. 

And many oil producers are hesitant to drastically reduce their output, as they risk being unable to pay workers or keep enough cash on hand to ramp up production once market forces improve.

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Experts say the crash will cut smaller, more vulnerable oil producers out of the market, centralizing production in the hands of a smaller number of larger firms.

The biggest factor in restoring the oil market will be the same measures that improve the economy in general — free movement of people to businesses. 

“The only thing that’s really going to help is getting demand back online which is going to require getting the country back open and people back in cars,” Braziel said, a process that could take months.