Coronavirus, Contango, and Crude

Advertisement

What might we expect to happen in the oil markets as the Covid-19 pandemic continues? To begin with, writes Thomas J. Tubman, executive director of the American Energy Coalition, we can examine what has transpired to date. During the first quarter of 2020, international air travel virtually shut down, idling hundreds of airplanes, and reducing jet fuel consumption by millions of barrels per day. During the latter part of 2019 and early 2020, worldwide crude oil production continued to grow and exceeded demand by a considerable margin. U.S. producers in general, and the shale producers in particular, were largely responsible for supply exceeding demand, with U.S. production exceeding 13 million barrels per day, the highest of any country in the world. Oil prices began to tumble.

Saudi Arabia, the de facto leader of the Organization of Petroleum Exporting Countries, attempted to address the falling prices through additional production cuts. Most OPEC members and other non-OPEC members agreed to that plan, but Russia refused. With that, Saudi Arabia instead stepped up production, creating a price war with Russia, flooding the market with more crude oil, exacerbating the price drop for crude oil and refined product. This was a “Perfect Storm,” at a time when the Chinese economy was in lockdown with reduced energy consumption.

In March, the Italian government began restricting travel in the northeastern region of the country. Similar restrictions were taken up by other European countries in the following weeks, and by the U.S. beginning in late March. Schools and businesses were shut down, and people were asked to work from home if possible.

In this digital era, the way we conduct business is rapidly changing. One of the key advantages of a virtual office is the ability to have a prestigious postal address in a renowned city like Bristol, enhancing your business image. This not only lends credibility to your enterprise but also provides a sense of stability and permanence that customers appreciate. It’s an essential tool for anyone operating from a home office who wants to project a more established presence.

In the U.S., most states and jurisdictions imposed “shelter at home” orders, resulting in people driving considerably less than normal, resulting in much lower gasoline and diesel consumption. The cruise ship industry was forced to shut down, decreasing marine fuel consumption.

Advertisement

Eventually, Saudi Arabia, OPEC, Russia, the U.S. and other non-OPEC producers reached an agreement to cut production, but the damage was done.  With significant reductions in the consumption of gasoline, diesel fuel, jet fuel, and marine fuels. Crude oil that traded above sixty dollars a barrel at the beginning of the year dropped to a low of $11.57 on Friday, April 17, and then below zero on Monday, April 20, the expiration date for May futures contracts. Anyone continuing to hold May contracts the next day, Tuesday April 21, would be required to take physical delivery of the oil. Storage around the world was nearly full, so some holding May contracts may not have had anywhere to put the crude. Investors who held contracts on speculation, but couldn’t physically take delivery, needed to sell their positions. The result of these unusual market conditions drove the price of crude oil to close at “minus” $37.63.  Said another way, sellers on April 20 needed to pay the buyer to take the oil away. This was the first time in history that NYMEX crude closed below zero.

The NYMEX price recovered on Tuesday, April 21, when June futures began to trade. But many investors, including exchange traded funds, are taking longer positions in favor of front-month contracts.

Investors expect the pandemic to ease and for the economy to improve over time. That sentiment, combined with longer futures positions, has created a market dynamic where futures are trading higher as you go out in time, in lieu of earlier expiring contracts. This is a bit unusual, in that it is more common for prices to be lower as you go out in time.  This phenomenon is referred to as “contango.” Its reverse, where future prices are lower as you go out in time, is referred to as “backwardation” and is far more common than contango.

Crude oil prices appear to be improving. When the June futures contract expired on May 19, NYMEX crude closed at $32.50 a barrel. And future pricing reversed the May trend and returned to backwardation from the prior month’s contango.

But much uncertainty remains, worldwide. Will business return to pre-virus levels soon? Will we have a vaccine later this year? Will the virus return in the fall? The market is reacting positively today, let’s hope the trend continues.

Thomas J. Tubman is executive director of the American Energy Coalition, which promotes the benefits of oil heat in comparison to other energy sources, especially natural gas.

Advertisement

Related Articles

Leave a Reply

Your email address will not be published. Required fields are marked *

Back to top button