There’s a scene in “The Godfather: Part III” in which Michael Corleone is in the middle of an argument between his nephew Vincent and a Mafia chieftain named Joey Zasa. Michael wants no part of it and declares in frustration: “What does all this have to do with me?”
If you’re in the trucking business and you want to know what today’s historic collapse in the front month contract for West Texas Intermediate crude oil means for you, the answer is: very little if anything, at least for now.
The enormous selloff in WTI came as the May contract moved toward expiration Tuesday. Since it is a physically based contract, if the contract ends the month and a trader is holding a “long” position, it would need to actually take delivery of oil.
The final eye-popping numbers are that the WTI contract on CME settled at minus $37.63 a barrel for May delivery, a drop of $55.90 per barrel. It had settled Friday at $18.27 a barrel. At one point toward the end of the day, it was wider than negative $40.
This means that if you held a long position in the May oil contract — you owned crude — and you had to sell it, by the end of the day you needed to not only deliver the barrels but also send the buyer $37.63 for each barrel.
Negative numbers have been popping up in some lightly traded oil markets in recent weeks so it is not unprecedented. But it is beyond stunning for a world benchmark like WTI.
But that wasn’t across the board. For example, the second month contract settled at $20.43 a barrel, down just $4.60. That contract, at least so far, doesn’t have the same risk of needing to take oil anytime soon if they don’t get out of their contract in time.
Given that WTI is physically delivered, there’s a problem — a big one — when there increasingly is no place to put it. The reason there is no room at the inn for all this crude is, first, the fundamental imbalance between supply and demand.
But what that has led to is that traders for weeks now have been engaged in what is known as the contango play. With demand collapsing because of COVID-19 and Saudi Arabia and Russia involved in a now theoretically completed price war with no restraint on production, it means that crude supply was far outstripping demand.
When that happens, particularly when it’s extremely exaggerated, like now, the current price falls further than the price for one month out, for six months out, for 12 months out and everything in between. If the spread is wide enough — and it most certainly is — it means that a trader can buy crude for current delivery, sell it for delivery further out and store it in the meantime, paying a storage fee that a few months ago was about 50 cents a barrel but now is reportedly pushing up toward 90 cents to $1.
The play was so profitable that it has been filling America’s crude oil tanks. (It’s also been boosting the stock price of companies with crude tankers, because the tankers can be used to store crude, just like the tanks on land in the U.S. and elsewhere.)
If WTI was a cash-settled contract, like trucking freight futures or the Brent crude contract, a trader with a long position on the final day would need to pay up that final day’s index price provided by the exchange to close out the position. It might be a lot but they wouldn’t need to worry about finding a place to store the crude.
So any trader that went into today’s trading with a long position had the real risk of having crude delivered to them with no place to put it. They had to sell to somebody with storage or had to close out their long position with somebody who had a short position. Clearly, a lot of traders with long positions had held out doing that earlier, hoping the market would reverse. When that didn’t happen, it was a race to the exits.
Here, then, is why it isn’t going to have much impact on the trucking sector, for now.
— The second-month price of WTI Monday, for June, was $20.43. That’s an enormous decline but it isn’t negative. It is that price that drives activity in the oil patch and the trucking work that goes along with it. Producers sell much of their crude on a postings basis, which is the price a gatherer pays to buy crude at the wellhead. On Friday, the Plains All American crude oil price for gathering West Texas Intermediate was $14.25. If you’re working in the oil patch, that’s ugly. But it isn’t zero.
— The price of Brent, the world benchmark, “only” declined 8.83%, down $2.48 to $25.60 a barrel soon after CME trading was completed for the day. Diesel prices move more in tandem with Brent than WTI because Brent and diesel are oriented more toward global markets given the significant amount of international trade in both. The end result then for ultra low sulfur diesel on the day then was a drop of, again, “only” 6.85 cents a gallon to 88.78 cents a gallon. It’s the first time it has settled at less than 90 cents a gallon since April 2004.
Where this is relevant to trucking and to any industry exposed to the price of oil is that there isn’t any reason to believe something like this can’t happen again. The fundamental problem that the May contract faced on its way out the door was no place to put excess crude; that’s not changing in a month.
The one thing that might be different is if producers start dialing back production rapidly. Rig counts have become less solid forecasters of production changes than they used to be, given technological advances in the shale, The Baker Hughes rig count released Friday recorded a North American decline of 78 rigs last week alone, with the U.S. decline of 75 rigs the most since March 2015, when oil prices were first starting to collapse on the back of so much shale production.
Additionally, the countries that agreed to cuts in the OPEC+ deal of a few weeks ago are set to start implementing them in May.
But for now, those in the trucking industry should remember April 20, 2020, as one of the most historic days in oil industry history. And while it certainly speaks to the broader fundamentals in the market, it isn’t hitting them much … yet.