Why Oil Prices Turned Negative

It's been a rocky road for oil this week, with U.S. oil prices falling below zero for the first time ever amid unprecedented weak demand due to the COVID-19 pandemic.

On Monday, April 20, the price of West Texas Intermediate (WTI) on futures markets plunged, closing out the day at negative $37.63 per barrel. To shed some light on what negative oil prices mean and how we got here, we're bringing you some highlights from experts around RBC.

First, to help understand how prices hit negative territory, RBC Global Asset Management (RBC GAM) offers a bit of insight into the fundamentals of how oil trades in the market. Here's how RBC GAM explains it:

"Commodities (such as oil) trade in standardized contracts known as futures. Originally, they were designed for farmers and businesses to obtain a level of price certainty by entering into a contract to exchange goods for cash at some future date." However, RBC GAM points out, many traders in today's futures markets are looking to profit from short-term price fluctuations, which it says can cause a disconnect between those trading in the market and those interested in actually purchasing the underlying commodity.

In essence, with May's oil futures contracts set to expire on Tuesday, April 21, traders scrambled to sell their contracts on Monday to avoid having to purchase – and ultimately store – the oil. With record low demand for oil, an oversupply of the commodity is pushing storage facilities to capacity, and in turn sending storage costs significantly higher. That led traders to sell off contracts in negative territory.

As RBC GAM points out, Monday's decline indicates "there was an overwhelming lack of demand for delivery of physical barrels of oil on May 1 – underscoring the sudden shock to demand that's occurred since the economy has been artificially shut down in response to COVID-19."

Market watchers note that this is more of market, or technical, phenomenon, so consumers shouldn't expect negative prices at the pumps.

The WTI contract for June was also significantly lower starting out the week, though remains in positive territory. Oil prices globally are under pressure amid the shutdowns caused by the COVID-19 pandemic despite a recent agreement by the Organization of the Petroleum Exporting Countries (OPEC) to cut production by 9.7 million barrels a day. Brent crude is the international oil benchmark, while WTI is the benchmark for crude from U.S. wells – and is the easiest to distill into products such as gasoline and jet fuel. Western Canadian Select, Alberta's most common crude oil, is the heavy oil extracted from the oil sands.

RBC Capital Markets Energy Strategist Michael Tran offers more insight into what's happening with WTI prices in a recent 10-Minute Take Podcast by RBC Thought Leadership, with host John Stackhouse.

"The market is sending a very clear message to oil producers: We're awash in oil in North America right now. Please shut in production," he says.

Tran points out that it's common to see some volatility around pricing as futures contracts expire, but with crude demand at historic lows, storage issues are weighing heavily on prices.

Tran likens the drop in crude demand over the past several weeks and months to a "slow-motion car crash."

COVID-19 has curbed travel globally, leading to significant declines in auto and jet fuel demand. Tran points out that U.S. vehicle congestion, for example, is down 83 per cent from normal levels, while U.S. flight activity is down about 71 per cent. Overall, he notes that about 4.1 million barrels a day of global jet fuel demand has been eroded.

"I don't think anybody anticipated really seeing oil prices fall to the levels we're seeing today," Tran says.

What does this all mean for Canada? There's no silver bullet, says Tran. With Canada's energy industry intimately tied to the U.S. (virtually all of Canada's oil is exported to the U.S.), he says the challenges will continue as demand pressures remain in place. Accessing other markets could help address those pressures. "If we had the Trans Mountain Expansion pipeline, Canadian crude would be able to reach the Pacific to gain access to key demand regions such as China," he adds.

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