The Real Reason Oil Futures Plunged On Monday Isn’t What You Think

Ouch! On the face of it, things look bad for the oil market.

That’s an easy conclusion to make from the epic dive crude oil futures prices took on Monday. But the bigger story is far more complicated than most would like to admit.

Most of the issue revolves around oil delivery rules and storage capacity issues specific to a single location in Oklahoma.

Futures prices for light sweet crude oil, which is commonly known as West Texas Intermediate, plunged approximately 40% Monday to around $11 a barrel, a 20-year low.

For sure, that’s a headline-grabbing event. It’s made fascinating by the fact that the drop in the futures prices over a few hours came just days after an agreement from OPEC (The Organization of the Petroleum Exporting Countries) to slash crude production by a whopping 10% of global output. Significant production cuts would tend to lift prices, and yet the opposite happened.

It would be easy to interpret Monday’s slide as a signal that the end of the world is nigh; that the economy is facing a financial Armageddon due to government lockdowns that are being implemented to fight the COVID-19 pandemic.

Don’t Jump to Conclusions

But that conclusion would be a mistake.

We have only to look at the price of Brent crude, the widely-used European benchmark, to see that things aren’t so bad after all. Prices for Brent futures fell around 5% Monday to approximately $27 a barrel. That’s not far off from where the price was last Thursday. In other words, Brent futures traders more or less shrugged when WTI futures hit the skids.

Why the plunge in one futures price but not the other?

Alexander Burgansky, head of oil & gas research at Renaissance Capital, says the matter comes down to the way that WTI futures contracts work and the lack of oil storage capacity available in Cushing Oklahoma.

Blame Lack of Oil Storage

WTI May-dated futures contracts, which expire Tuesday, require futures buyers to take delivery of the oil in Cushing. But given that there is little if any storage space available in that location the traders are ditching their contracts, Burgansky explains.

“[O]il traders are selling tomorrow’s futures to avoid taking a physical delivery,” he wrote in a recent report. Instead, traders are now buying June-dated contracts, which recently were fetching approximately $23 a barrel.

None of these gyrations are happening with Brent crude futures. Brent crude can be delivered offshore to a variety of locations, explains Burgansky. If there isn’t much storage in one place then the oil can be delivered elsewhere.

In simple terms, the flexibility of the Brent futures contract means that lack of storage in one place isn’t forcing traders to dump futures contracts in the way that it is with WTI futures.

Forbes