Why WTI dropped to unprecedented low
The US crude Western Texas Instrument (WTI) slumped below 0 dollar for the first time in history while its peer Brent comparatively remained stable, dropping 9 per cent to $25.57 a barrel on Monday. Currently, there are only three main grades or benchmarks for oil — Brent, WTI and Dubai/Oman — and these are traded on ICE Futures Europe, New York Mercantile Exchange and Dubai Mercantile Exchange, respectively.
Q: What are oil futures and how do they work?
A: Futures are advanced contracts and highly volatile. Buyers and sellers of crude oil agree to deliver specific amount of oil on a given date in the future. Oil futures are traded because oil extraction and delivery via tankers is a timeconsuming process. Since factories and economies need assured oil supply to run smoothly, they sign advanced contracts – called futures.
Q: What does a negative futures price mean?
A: The price of a barrel of crude varies based on factors such as supply, demand and quality. Supply of fuel has been far above demand since the coronavirus forced billions of people to stop travelling. Because of oversupply, storage tanks for WTI are becoming so full it is difficult to find space. “There’s no available storage anymore so the price of the commodity is effectively worthless,” said Bob Yawger, director of futures at Mizuho in New York. “So when it’s minus a dollar, they’ll pay you a dollar to get it out of there.”
The price plunge was partly due to the way oil is traded. A futures contract is for 1,000 barrels of crude, delivered into Cushing, where energy companies own storage tanks with roughly 76 million barrels of capacity.
Each contract trades for a month, with the May contract due to expire on Tuesday. Investors holding May contracts didn’t want to take delivery of the oil and incur storage costs, and in the end had to pay people to take it off their hands. The June contract, with delivery a month away, is still trading at above $20 a barrel, but the price crash indicates that most storage space has been gobbled up.
Q: Why WTI fell on Monday?
A: The key reasons for the decline in WTI price was slump in demand, shortage of storage capacity in the US and expiry of the future contract. Demand slumped due to impact of coronavirus on global economy. While refineries rejected WTI crude supply because storage sprinted to the brim. Under futures contract, WTI needs to be physically delivered while Brent is deliverable offshore. Given logistics and storage constraints in Cushing, Oklahoma (where WTI is stored) for physical crude amidst low demand, traders started selling Tuesday’s futures to avoid taking physical delivery. This pushed WTI price into negative territory on Monday.
Q: Will fall in WTI benefit the UAE residents?
A: Due to contagion effect from the fall in WTI and Brent, it is highly likely that the benchmarks on which UAE oil prices are fixed each month will go lower and hence we could most likely see lower oil prices for UAE residents in May 2020. UAE retail oil prices are based on S&P Global Platts which is a benchmark for refined petroleum products. UAE Retail Pricing Committee for Refined Petroleum Products adds margin and transportation/logistics cost etc. to the Platts prices to arrive at the retail prices for refined petroleum products each month. Global Platts price changes are linked directly to the changes in the Brent crude. Q: What does it mean for airlines?
A: For cash-strapped airlines, the decline in crude prices will make it cheaper to operate flights that are already nearly empty as people remain homebound due to the coronavirus. The plunge in crude futures also indicates that the market does not expect airlines to add back many flights to their slimmed down networks any time soon, said Raymond James analyst Savanthi Syth.