So they start off the article with this statement:
"That means oil producers are paying buyers to take the commodity off their hands over fears that storage capacity could run out in May."
This statement is actually totally false. Producers already got paid for this production a long time ago when they initially sold the futures contract. What has actually happened is that as the expiry of the May futures contracts arrives, the traders who bought those contracts are now trying to unload them at all costs. This is because if they're stuck holding the contract at expiry, they have to take physical delivery (each futures contract represents 1000 barrels of oil), and the cost of storing that oil is getting really high since the storage facilities are nearly full.
Later they kind of explain this in the article:
"The severe drop on Monday was driven in part by a technicality of the global oil market. Oil is traded on its future price and May futures contracts are due to expire on Tuesday. Traders were keen to offload those holdings to avoid having to take delivery of the oil and incur storage costs."
But I think it's pretty irresponsible journalism to kick off the article the way they did, and imply that producers are paying you to take their oil today.
If anything, this is a wild understatement. Each contract represents 1000 barrels of toxic waste. You can't just have that stored in a shed or something. And all the commercial regulation compliant storage is gone. I'd be willing to bet you will have a hard time even finding a tanker truck to take it to a buyer, since the tanker owners themselves are going to be using those trailers as temporary storage facilities. Anyone stuck taking delivery of barrels right now is in for a world of hurt. The legal fees alone are going to be ruinous.
In the USA at least, EPA enforcement has been drastically relaxed to allow a bit more freedom in regard to this issue in exchange of public safety and environmental stability.
I wouldn't be surprised if someone doesn't see the opportunity to just dump oil from their tankers to take on an additional lucrative storage contract from a speculator caught off guard.
ELPC just released this report for example claiming the number of facilities regulated by the EPA that are out of compliance have doubled in the last year.
> EPA enforcement has been drastically relaxed to allow a bit more freedom
EPA enforcement has been relaxed because the toxic sludge dumpers with influence in the Trump Administration have always wanted to gut environmental regulations and avoid legal liability for giving their neighbors cancer, but now they have a convenient excuse.
Forgive me if this is a stupid question but they canβt hold a gun to your head to force you to take the oil, right? Canβt you just refuse the delivery if you have nowhere to store it? Is there language in the contract for this kind of situation?
In this sense "barrel" is a unit of measure. The oil is physically in tanks in Oklahoma. When oil is delivered it stays in the same tank, but the ledger for the tank contents are updated.
Once delivery is made you are now on the hook for the storage costs - which are going sky high because there is no available storage inventory. You can default on your obligations to the storage company, but they will sell off whatever oil you hold to cover debts and then sue you for the rest.
When the market is functioning correctly you end up paying for a few days of storage while the oil is diverted to a pipeline where you can extract it, or it is offloaded on to your train/truck/tanker/etc.
That's not a stupid question it's an excellent one. If you don't take delivery you're in breach of contract. The penalties for that are going to depend on how the judicial process works out.
This has never happened before, so I don't know how it will play out other than that it's going to be wildly messy. Probably far messier than anyone, myself included, is imagining.
>That's not a stupid question it's an excellent one. If you don't take delivery you're in breach of contract. The penalties for that are going to depend on how the judicial process works out.
That sounds incorrect. The whole point of having standardized, commodified units trading on organized exchanges is that you donβt have to reinvent the dispute-resolution wheel β or turn it over to super slow courts β for every foreseeable thing that can go wrong. So there should be a specific procedure and penalty you can look up.
I asked the same question and got this answer that seems more correct and along the lines of my intuition, that the exchange holds it (or rather, directs others to home it) and bills your account for the cost:
The contract[1] assumes that Cushing has storage capacity. IANAL so I don't know how material that will be, but I continue to expect that lawyers will get involved and this will be a mess.
In an arrangement with the US Government it could be put into the ground, elsewhere. Doing it without state permission would be an entirely different matter however. I'm not aware of any very large, privately owned underground storage caverns (such that they could make a dent in absorbing the over-supply).
This is being discussed:
"The U.S. Energy Department is negotiating with nine companies to rent about 23 million barrels of oil storage capacity in its Strategic Petroleum Reserve as part of a Trump administration bid to help drain the countryβs growing glut of crude."
Here is what the US Strategic Petroleum Reserve looks like (it can absorb some of our over-supply briefly):
> Four underground salt caverns on the coast of the Gulf of Mexico store the oil. That's a central location. The oil can be distributed to nearly half of the U.S. oil refineries either through interstate pipelines or via barges. It only takes 13 days for the oil to enter the U.S. market from the time the president first gives the order.
> There are two cavern locations in Texas. As of September 30, 2018, Bryan Mound held 235.3 million barrels in 20 caverns. Big Hill held 153.4 million barrels in 14 caverns. The other two are in Louisiana. West Hackberry held 199.5 million barrels in 22 caverns. Bayou Choctaw held 71.88 million barrels in 6 caverns.
> The maximum capacity of all four caverns is 727 million barrels.
Why should the American people pay to fill it when they can now be paid instead to store the oil? The market's decided that the toxic asset needs to go somewhere and the speculators that bought it (not the producers) will pay.
>The workaround is to cheaply rent out the reserve as storage space
Cheaply? They took a risk in speculating and it didn't work out. The solution is to give them a choice: surrender their oil to the USG (to avoid paying storage fees) or pay the USG for the service of storing it.
I can understand the impulse, and absent any middlemen it would make perfect sense to have the government step in to buy excess production during a crisis to fill national reserves.
But we have speculators who sold us the idea that their profits brought stability to the market, so make them keep playing by their own rules.
It's not a bailout. Prices were negative! We'd literally be _getting paid_ to take oil and put it into our reserve. It's literally the easiest financial decision on the planet.
The fact that Pelosi blocked it demonstrates a fundamental lack of understanding of basic finance.
Hm, I can't find any sources to this effect. Have one? I vaguely recall a bit about paying over market for petroleum to refill the reserve, with the idea being we fill a demand and prop up the gas industry.
The USG can top off the reserve at any time and it'd be chump change. They're spending trillions of dollars these days. They're not concerned with a few billion dollars worth of oil here and there.
I love this question! Mainly because first I laughed at "But that would be silly -- we spent all this effort taking it out of the ground", but on second thought it represents a reasonable thought of "We got it from the ground, therefore the ground isn't the worst place for this stuff maybe?".
Reconfiguring wells to reverse flow is a lot of work, and would take a significant amount of time to setup. This can happen with old gas wells, excess gas can be compressed and reinjected into the well, but they are specially designed systems.
This sort of refusal would likely has contractual penalties associated with it. Drillers and pipeline operators can't just shut down infrastructure by flipping a switch like it's nothing; it costs real money to perform shutdown procedures or restart pipeline pumps.
I bet all the lawyers who put such clauses in futures contracts are feeling pretty smug right now. I can imagine an oil producer going "Why on earth do we need to put this in the contract? Of course they'll accept delivery. If they don't then that's great for us."
That's actually a really good point. I've gone through plenty of contracts that are 20+ pages in length and wondered if they really need to be that long.
It's times like these that those contract clauses protect you, in a big way.
Eh, they probably thought it (however unlikely) could happen for reasons other than a pandemic. Like unprecedented green energy incentives leading to everyone suddenly driving an EV.
That example is a bit implausible. This is only a problem when oil prices fall very low very quickly. Manufacturing constraints prevent mass EV adoption on those timescales.
On the other hand, people who draft contracts for big corporations get to talk to risk analysts and ask "if we agree to this, what might go wrong that causes us to lose money?" and write clauses that generally protect them from that risk.
When it costs you nothing to add a clause to a contract, you don't need to come up with a plausible scenario for how something could happen, you only need to foresee the logical possibility of it occurring for any reason whatsoever. Part of managing risk is understanding the world is much more creative at coming up with failure scenarios than you are.
That sums up my intention. I shouldn't have provided an example, for precisely the reason you describe: it's not likely to be what causes the clause to be invoked.
Well, you'll be on the hook for the storage costs until you arrange somewhere for it to go, so in that sense, yes they can. Yeah, you can sell the oil to someone else in the future, but when? Meantime, you owe rent.
You are required to post cash collateral in order to take out a futures position. It's calibrated so that the cost of abandoning that collateral is large enough to basically be a gun to your head. Furthermore, when the price of the contract moves, they mark-to-market your collateral and credit/debit you your daily gains or losses.
Basically, the people holding the contracts have to either sell at a negative price to cover, pay to take delivery, or give up cash collateral that's worth even more money than the previous choices.
Rejecting delivery would be no different than any other contractual arrangement, like buying a car or selling stock. If you decide to not follow the contract, you'll be sued.
> Producers already got paid for this production a long time ago
It's a future market for the public. You don't know which side you are trading with (trader or producer) but they are all trading at all times even if they are not transacting.
Here is an example: Let's say you are a producer that a sold a future contract a long time ago at $25. You have the opportunity to buy that contract again today at -25$ and close your position. You have no oil to deliver + you made $50 per barrel more than what oil is trading at in Europe.
Given that we can conclude:
- Big producers are refusing the close positions to keep prices down. (or maybe they have a legitimate reason why they want to deliver their contracts?)
- The market temporarily dipped because of leveraged trading. Traders were a sleep/slow to react. (they don't have automated bots?)
- This price range (maybe not -25$ but maybe $5-0) is the real price of oil for these few days.
> Big producers are refusing the close positions to keep prices down. (or maybe they have a legitimate reason why they want to deliver their contracts?)
They have legitimate reasons why they want to deliver their contracts. Crude oil is highly toxic, they only have so much storage available, and shutting down wells incurs significant costs. If they don't buy back their short futures position at -$25/barrel, that means shutting down costs them at least $25 per barrel no-longer-produced.
Well to be honest, although it may not be true for oil, it can definitely be true briefly for electricity, because itβs use it or lose it. Battery storage is still in its infancy.
Negative prices are definitely a thing when you canβt stop production and all of a sudden storage or middlemen are over capacity.
LOOK AT WHAT IS HAPPENING right now in the US food chain! The farmers have to euthanize cattle rather than sell them because the price they get is lower than upkeep. Yet the price of meat at the supermarket is going up and up. Whatβs going on? Well, the processing plants have shut because theyβre sending employees home if anyone is infected, and so the capacity of the middlemen drops. And boom, there is a huge inefficiency now.
Someone in congress is working on a bill to let the farmers and supermarkets disintermediate... as usual, decentralization to the rescue.
> Producers already got paid for this production a long time ago
Nothing requires a broker to be involved. Drillers can sell futures to "get paid now" for future production, and likely did so to cover expenses in these chaotic times.
If they issued a contract for 1000 barrels on the 1st of the month, produced that 1000 barrels on the 10th, and have an unsold contract on the last day of the month - they are screwed.
It reminds me of a funny story in Options, Futures, and Other Derivatives, where some newbie trader mistakenly bought a contract on live cattle futures to close out a long position. The trader spent a couple weeks traveling thousands of miles and figuring out housing and food for hundreds of cattle until a buyer for them could be found.
But does this mean that the contract holder is paying someone to take their oil in the future? It feels significant that someone in the chain from producer to consumer is now paying to have someone take their product.
It's a physical asset, with strict environmentally regulated storage requirements. Holding it speculatively for 5+ years requires that the speculation will pay in excess of the storage fees compounded at a reasonable risk adjusted rate of return for the 5 year duration.
This is a great deal if you happen to own cheap oil storage, I wouldn't be surprised if the main buyers of these contracts are the storage companies.
Since oil is making the front page here, if you're interested in the history of American oil industry, "The History of the Standard Oil Company" by Ida Tarbell is a fantastic read. It's also a great example of investigative journalism.
In early chapters of the book she covers the initial rush to pump oil in the Oil Regions and the history of pipelines and storage facilities as it all ties into business practices of Rockefeller.
Oil storage facilities were an interesting startup idea back then, in the beginning producers would pump the oil into open pits where it would seep back into the ground if it wasn't transferred fast enough, then of course new ways of storing and transporting the oil were experimented with. It also goes into how much supply/demand were at odds in the beginning leading to several collapses in the price of oil when there wasn't such a diverse market. Again some of the issues we still see where land locked areas of producers struggled to get their product out of the region and how local economies caused drastic prices differences that we're seeing right now.
Ida Tarbell's father was an oilman who was ruined by Rockefeller and Standard Oil while she was a girl, which is important to keep in mind when contextualizing her work. She lived her life in part as a crusade against Standard Oil and Rockefeller. Obviously she was heavily biased, this being instilled in her early on.
For a less biased look at the history of the American oil industry by way of Rockefeller and Standard Oil, I strongly recommend Titan by Ron Chernow - author of Hamilton - which is an excellent account of Rockefeller and Standard Oil, both the good and the bad.
More specifically, West Texas Intermediate Crude futures for early May delivery are sub-zero. Late-May delivery is more expensive.
This is in part a reflection of the fact that the oil producers have already been paid for the output and are contractually obligated to deliver it, but no one actually really has a use for it once it is there, and it will cost money to transport or store it.
It can't just be producers being contractually obligated to deliver it, can it? If that was the case, couldn't they close out their obligation by buying back some of these futures (at a profit), and "delivering" it to themselves by reducing production? So it must be that reducing production itself is not possible or too expensive for this to make sense.
If you owned an oil ship, what stops you from getting paid $25 a barrel to fill your ship up with oil, sailing to international waters, dumping it all in the sea, then go right back to port and do it again and again getting paid $25 a barrel each time?
These are only the prices of the "futures contracts". i.e. oil that hasn't been produced yet, as far as I understand. Actual physical oil still has a price > 0. (Spot price)
Although this is largely a paper phenomenon, the thing to pay attention to now is ripple effects.
A few weeks ago, Capital One was granted a regulatory waiver from the CFTC over its oil derivatives positions - a waiver it since declined to use:
> The registration is related to Capital Oneβs commercial lending to the oil and gas industry, a relatively small part of its overall business. The bank enters into commodity swaps with energy clients to help them mitigate the risk of energy price swings and the related borrowing risks.
Most people don't immediately think of Cap One as an oil futures player. But its lending business caused it to enter the market to hedge some of its loan portfolio.
Given the highly unusual nature of what happened today, it wouldn't be surprising to see future announcements of banks or other financial institutions getting into trouble over commodities derivatives bets going pear-shaped.
In one of the articles, it quoted someone from, I think, the CME, that said they were fully prepared in their trading systems to handle these negative prices with no hiccups.
What I immediately thought, that I haven't seen anyone else mention yet, is that there are some admirable programmers!
Ex-trader at GS/MS here. PMs in this case are traders, requirements about trading systems come from traders b/c they have to dog-food it. Usually there is no separate PM in the tech world sense at banks, though there are project managers.
Any futures market provides calendar spreads as well, which represent a price differential between two dates (think: CLK0 is the May contract, CLMO is the June contract, and CLK0-CLM0 is the difference between the two). CME's systems should trivially handle negative prices because they already have spreads, which are frequently negative.
It still appears more significant by the way futures trading works and the way it all bulked up to the last trading day, since there was no buyers after a certain point - because (certain) buyers were incentivized to wait until the last minute to submit orders, to get the cheapest price.
In a "real" market with physical oil wells + storage, wouldn't that decline in consumption -> storage normally happen far more gradually over time? (A drop over a week is less exciting than a down spike within 24hrs) I know it's less efficient that way and all of that, but this seems to make it appear like this drop in the market happened all at once.
A lot of non-experts will see the news this way regardless - it's slightly less exciting in context but still historic.
Futures prices were indeed negative, specifically the soon-to-expire May contract. June and beyond stayed positive, but this is the first time in history that the contract (any expiry) has traded at negative prices. This is a noteworthy event.
Oil deposits are permeable rock with a mix of oil and water in the pores. Pumping oil down into such a formation would be slow and expensive. It would also take different equipment from that which is there at the wellheads now, so you couldn't get started right away.
So, where are all the arguments now about why speculators should be required take delivery? I mean, really, the oil producers got paid and consumers shall have copious supplies of oil.
Nobody out looking to find excuses to further regulate commodities markets when all the traders are losing their asses.
Oil costs $ to store. Due to the economic collapse, oil isn't being used much. So all the storage facilities are filled up. So nobody who can store it will buy it from you. If you want to get rid of oil, you have to pay someone.
The smart equivalent is to get a tanker ship and just float it out at sea until someone wants the oil (usually just west of Africa, where you can easily dispatch it to whoever ends up needing it.) Not sure if it works quite as well with WTI instead of Brent crude, though.
It is probably a fair and terrible assumption that others have thought of this already and that, in fact, tanker ships are filling up all over the place right now. Statistically, this means we're more likely for a spill, somewhere.
"Lease rates have soared for very large crude carriers, the 2-million-barrel high-seas behemoths known as VLCCs. The average day rate for a VLCC on a six-month contract is about $100,000, up from $29,000 a year ago, according to Jefferies analyst Randy Giveans. Yearlong contracts are about $72,500 a day, compared with $30,500 a year ago. Spot charter rates have risen sixfold, to nearly $150,000 a day.
Day rates rise as the spread between oil-futures contracts widens. The basic math is that every dollar in the six-month spread equates to an additional $10,000 a day that can be paid for a VLCC over that time without wiping out all the oil-price gains, Mr. Giveans said."
But there's plenty of Saudi oil going in as well.
I'm not sure that they're materially more at risk of a major spill than during normal operations.
I might be in minority, but I think this is great for the clean energy sector and environment. The oil is not being used and thus not being consumed and converted into toxic products (carbon dioxide, and various other vehicle emissions) which are leaked into the environment.
I hope these oil companies dissolve over this unprecedented event.
On the other hand, thereβs some potential good that could come of it. Some people whoβve felt trapped in dead end jobs are getting new opportunities. Who knows if the good changes that result will outweigh the bad, though.
Yes it will, this thing is far from over. It will have huge consequences on civilization as we know it. It also demonstrated how weak all our economic systems are.
You can close your position by buying the month after futures. This will require you to store crude oil for just one month. I think the issue is that storage facilities are almost booked out and the remaining capacity is just so expensive.
It's entirely possible that no barrels will be effectively sold at a negative number. Because even after expiration you can negotiate OTC, it depends. At the very least, the final print likely will be renegotiated.
There should be a meme:
75 year old baby boomer: I remember when gas was less than a dollar a gallon
45 year old son: me too!
15 year old grandson: me three!!
https://news.ycombinator.com/item?id=22923025