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A negative oil price – a market quirk, or the ‘new normal’?

A negative oil price – a market quirk, or the ‘new normal’?

21-04-2020 | インサイト

The price of US oil temporarily dipped below zero for the first time in history, which means an oil supplier has to pay someone to take it off their hands. The May futures contract for West Texas Intermediate (WTI) reached minus USD 37 a barrel on 20 April before recovering to a more normal plus USD 20/bbl – itself an 18-year low. In this Q&A, Rob Schellekens, portfolio manager in the Emerging Markets Equities team, explains how it happened and what it all means.

  • John Coppock
    John
    Coppock
    Investment writer
  • Rob Schellekens
    Rob
    Schellekens
    Portfolio manager

WTI dropped below zero – this is unprecedented. What exactly happened?

“Oil is sold in monthly futures contracts. When WTI contracts expire, which they did on 21 April, you have to physically hand over the oil. This is not something that happens with Brent Oil, for example, where you can settle in cash. With WTI, you can either roll over to the next month, or deliver in physical barrels. If you take the barrels, the problem is it has to go somewhere, and demand is thin while storage capacity is almost full. A significant part of the owners of the futures are financial investors who do not want to take the oil. In this unprecedented situation, some of them have chosen to pay people to take it off their hands, and that’s when you get the strange situation of negative pricing.”

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What are the underlying causes of this anomaly?

“It’s basically caused by a perfect storm of current over-supply and a sudden and catastrophic drop in demand. The oil market has seen strong production growth for the last few years from the US shale oil producers; the OPEC nations tried to balance the market with production cuts, but with limited success. And then we got the coronavirus situation, when global demand for oil suddenly dropped – by some estimates by 20-30 million barrels a day, or about 20%-30% of normal global consumption. That is because many countries have been locked down, with limited flying in planes or driving cars. This situation, combined with the expiration of the futures contracts, have brought about the negative prices.”

What is to be expected from oil prices in the coming weeks?

“It’s going to be volatile due to many factors at play. The two biggest questions are of course when will global demand start to recover – for this, the lockdowns need to be loosened or ended? And secondly, what will happen on the supply side? Will OPEC+ come up with another agreement, and to what extent will US shale oil production decline? Our expectation is that oil prices will stay lower, but volatile, until at least the second half of this year, and will then slowly recover as the global economy starts recovering as well.”

How do oil prices developments impact our portfolios?

“Depending on the strategy, by and large, we have modest exposure to the oil segment. From a country perspective, we are underweight the majority of the oil-exporting nations such as the Gulf states, Mexico and Malaysia, and are slightly overweight Russia. So, the portfolios are more geared to the oil-importing countries which should benefit from a lower oil price. Within the energy sector, we are more exposed to gas, distribution companies and integrated energy, and not to pure play upstream oil.”

Will structurally low oil prices hinder the energy transition?

“We believe that these very low oil prices are not structural in nature and that the path taken to transition the energy mix will be followed. In the meantime, the speed at which the transition takes place can vary. For example, in the European power generation sector (which is one of the first segments to transition), the use of gas in the power generation mix has increased over the recent past at the expense of coal. Part of this can be attributed to the low cost of natural gas at the moment. Oil is only a small part of this energy mix, some 4% globally.”

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