Why WTI Oil Prices Crashed
The U.S. crude oil market ventured into unprecedented territory on Monday, April 20, when prices turned negative. Futures on the New York Mercantile Exchange for soon-to-expire May contracts of West Texas intermediate crude oil, or WTI, fell to -$37.63 a barrel by the time the market closed. WTI serves as the benchmark for U.S. crude oil prices.
What caused U.S. crude oil futures contracts to turn negative?
Crude pricing is dependent on factors such as as quality and supply and demand. In this case, the plunge in pricing was closely tied to the way crude oil is traded. Futures contracts for U.S. crude oil are sold 1,000 barrels at a time with delivery taking place in Cushing, Okla., where there is approximately 76 million barrels of storage capacity.
On Monday, a unique situation played out as traders who were long on May contracts for WTI scrambled to sell their positions. These traders were caught in a precarious position because their contracts, which expire today on April 21, require them to take physical possession of the oil. Rather than pay to store the crude, the traders decided it would be cheaper in the end to pay someone else to take the oil.
Oil storage capacity is dwindling because the coronavirus has wiped out demand as people have stopped traveling and economic activity has been curbed. It’s estimated that as many as 30 million barrels per day – or the equivalent of what had been 30% of global demand – has been pumped into storage globally in the past two to three months. The U.S. Energy Information Administration said last week that crude oil storage capacity at Cushing, was about 72% full as of April 10.
June contracts for WTI are still trading above $20 a barrel, but it’s not out of the question that they, too, could continue to fall as storage options become scarce.
MFA Oil Hedging Manager Tim Danze says the historic fall in crude pricing is indicative of the way the pandemic has upended energy markets.
“This was a unique situation with the May contracts expiring, but it does show just how much demand destruction has taken place and the extent of the global oil supply glut,” Danze says. “This isn’t a situation that’s going to right itself overnight, it’s going to take some time for supply and demand to even out.”
How will the decline in crude prices affect fuel prices?
Given the precipitous fall in crude prices, many consumers want to know if they can expect to save on their next visit to the gas station.
Currently, the national average price for a gallon of gasoline stands at $1.80 per gallon, which is down more than a dollar compared to last year’s average price of $2.84 at this point in the year. Diesel prices, which average $2.49 per gallon nationally, are down from an average of $3.08 per gallon at this time last year.
“Generally crude, gasoline and diesel prices trend together, but it’s not a given that fuel prices will continue to mirror what we are seeing with crude futures,” Danze says.
The price of oil makes up more than half the cost of the price of a gallon of gasoline, but there are several other layers of costs including refinement, transportation and various state taxes. Additionally, it typically takes several days for crude pricing differences to show up in retail fuel pricing.
Tom Kloza, head of global market analysis for Oil Price Information Service, told MarketWatch it’s unlikely the collapse in May U.S. crude contracts will directly translate into a dramatic decline in fuel prices for consumers.
“The futures market has its own ecology and that really was at work (yesterday),” Kloza said. “It’s more about the inner workings of trading and investors and trapped longs than it is about…typical supply and demand fundamentals.”