We can start with the storage capacity situation at Cushing and a discussion of paper markets. In paper markets, such as crude oil futures, financial positions must be reconciled at contract expiry with physical delivery. Typically, a speculative financial position is opened with the intent to close or offset it prior to contract expiry.
If an entity with such a position lacks the ability to take physical delivery perhaps due to no access to storage or immediate demand , then that entity must liquidate its financial position in the futures market before the contract settles. All evidence indicates this is exactly what happened to the prompt contract for WTI.
With no ability to store oil, large paper positions had to be liquidated. This indicates a massive oversupply of paper, not physical oil, thereby driving the contract settlement price down.
Make no mistake, in normal circumstances neither of these things would have occurred. This is the result of a devastating collapse in demand that has occurred in the wake of the COVIDdriven economic shutdown, and is a realization of regional constraints in this case storage becoming scarce that can drive significant discrepancies across regional prices. It is important to recognize that the global physical crude oil market is still pricing in positive territory.
Yes, there are some regional spot prices that are in negative territory. But this indicates an extreme oversupply condition that is local, which should stimulate shut ins of immediately impacted physical production until demand can pick up to restore balance. The negative pricing signal we saw on April 20 for the May WTI contract settlement on the NYMEX is an indication of a financial long position that was too large to be physically accommodated.
It also indicates an emergent albeit temporary reality that speculative long positions in crude oil futures will be punished as places to put crude disappear. Whether or not this happens to the June contract will depend the evolving supply-demand balance, which will reflect production shut ins which appear to be accelerating , near term demand recovery which is still very uncertain and dependent on economic activity being restored , and the extent to which storage fills which is itself a reflection of production and demand.
So, given the uncertainties involved in the current oil market, April 20 could be a harbinger of things to come; or, it might not. Given the extreme volatility and associated downside risk, it is likely that production shut ins will accelerate over the next few weeks, which will alleviate mounting pressures on storage.
But it is important to dig a little deeper before making such a proclamation. Indeed, we see positive values out along the forward curve for WTI, indicating the market still views crude oil to have some future value See Figure 2. At the very least, an ability to buy May and sell June would yield a return that any trader would love to reap, but if arbitrage is capped by a lack of ability to store oil, then that opportunity is not on the table.
Suffice it to say that everyone is scrambling for answers to the storage shortfall, as well as grappling with how long the current oversupply situation will persist. While the immediate term is rife with uncertainty, one thing is certain: oil market recovery cannot commence until the economy picks up. Looking longer term, the current market stress may bring the notion of position limits back into the limelight. Such a rule could require, for instance, storage capacity or at least a position in storage for entry into the crude oil futures market.
The oil hub of Cushing, Oklahoma, has overcome times of stress before without losing its prime role in US oil pricing. But when it made history on April 20 with a headlong dive into negative pricing, the potential difficulties of using it as a pricing benchmark for oil trade in other US markets and beyond was highlighted like never before. Negative prices have been seen only rarely and not usually for long , with examples from recent years including cases such as associated gas in far western Texas or even very light natural gas liquids in Western Canada.
In both cases, the commodity in question was an unwanted byproduct alongside more valuable crude oil, and on the whole had to be sold even at a negative price in order to keep the more valuable oil flowing. But this is not what happened at Cushing. Cushing is something of an outlier among the major oil benchmarks, as it is not particularly close to either major production or consumption areas. What it does have is a lot of physical infrastructure, with a wealth of pipeline connections and a commercial crude storage capacity that is unrivaled.
By comparison, North Sea Brent crude , widely used as a benchmark in Europe and in markets around the world, is based on trade in physical waterborne cargoes of five different crude grades. While Brent's nominal storage capacity is lower than WTI at Cushing, it is intrinsically linked to the global market, with the crude making up the Dated Brent benchmark easily deliverable by tanker to refiners in any continent.
WTI price and differentials Cushing lacks this easy access to the global market, so if you buy oil, you need a storage tank to put it in, and for several weeks now, that storage has been getting steadily fuller. The scale and speed of the precipitous drop in oil demand has left the market incredibly oversupplied, and despite the best efforts of producing countries, that oversupply is weighing heavily on prices.
This played out in extremis on April 20, when anyone needing to sell May WTI crude found there were no buyers left in the market until they chased them all the way down into negative territory - market forces, turned up to WTI crude at Cushing is one of the most-watched and most-referenced crude prices in the world.
Traders of other physical crude grades in other locations, notably the major US Gulf Coast market built around Texas and Louisiana, typically buy and sell oil at a differential to Cushing.
Cushing is known as "The Pipeline Crossroads of the World. The significance of a benchmark in the oil market is that benchmarks serve as a reference price for buyers and sellers of crude oil. Oil benchmarks are frequently quoted in the media as the price of oil. Though Brent crude and WTI crude are the most popular benchmarks, their prices are often contrasted.
WTI is not the most commonly used benchmark globally, that honor goes to Brent, where two-thirds of oil contracts globally use Brent as a benchmark. Both, however, are considered high-quality oils and are therefore the two most important oil benchmarks in the world. As mentioned, WTI has a sulfur content of 0. The lower the sulfur content of an oil, the easier it is to refine, making it more attractive. A sulfur content below 0. WTI is ideal for gasoline whereas Brent is ideal for diesel.
Theoretically, WTI crude should trade at a premium to Brent crude, given the quality, but this is not always the case. While the two crude oil varieties can trade at similar price points, each one has its own unique supply and demand market, and therefore its price reflects its individual market fundamentals.
Since the shale boom in the U. Furthermore, transporting WTI overseas to Brent crude's market could come at a cost that would make WTI unable to compete with Brent crude in terms of pricing. Energy Trading. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page.
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