As Clear As…Oil?

Along with unbelievable unemployment numbers and economic data and an incomprehensibly huge price tag for government stimulus so far, crude oil prices that are less than zero are another bizarre number resulting from the strange times of COVID-19.

Why and how is oil "negative" and what does that mean? How come a barrel of oil costs less than a gallon of gas?

Oil Defined

Crude oil, unrefined petroleum, is typically quoted as either West Texas Intermediate (WTI) or Brent. WTI comes out of the ground in landlocked areas in the Western and Central United States and is mostly stored in a massive storage facility in Cushing, Oklahoma. WTI can be thought of as "American price". Because the production and storage of WTI is entirely domestic, WTI prices are usually relatively well insulated from global geopolitical events.

Brent crude comes from undersea reserves in the North Sea and is stored all over the world. It is stored everywhere, including in oil tankers all over the ocean. Two-thirds of the world's oil is quoted in Brent prices, including oil from the Middle East and Russia. Brent can be thought of as "International price", and because it is stored globally, it is more vulnerable to international geopolitical events.

At least, this is how things normally are! Very little in the world is normal these days.

What is a Negative Price?

As with any price, the price of oil falls when supply exceeds demand. The global economic freeze and stay-at-home response to COVID-19 has caused global oil demand to plummet in the short term, while production has not slowed much.

Because of this, the storage facility in Cushing, Oklahoma reached full capacity (based on present storage and space that is already spoken for by producers) and there is still more oil on the way.

On Monday, April 20th, it became clear that WTI futures contracts expiring in May would result in traders owning barrels of oil with literally no place to put them. Just for some physical perspective: a single typical oil contract is for 1000 barrels. A typical oil tanker truck that you see on the highway holds about 200 barrels. Needless to say, very few people can handle the physical oil represented by just a single contract.

Traders dumped the May contracts so that this wouldn't happen to them and the result was that the price of the WTI contracts to receive oil in May became negative. The "price of oil" was below zero for the first time.

It's important to note: the price of the actual oil isn't negative. Nobody is going to sell anything of value that they own for a negative price. Rather, the price of the piece of paper that obligates someone to take delivery of thousands of barrels of WTI oil next month has negative value because you can't park it at the Cushing facility. I would rather pay someone to take this responsibility from me than take custody of several tanker trucks' worth of oil, and incur all of the related costs, and I'm guessing you would too.

Because of its more global nature, and because of the relative ease of moving offshore oil to distant storage facilities by tanker ship, Brent oil is less vulnerable to sudden oversupply and local storage shortage issues than West Texas Intermediate, and so has fluctuated less recently.

So, why does a gallon of gas cost more than a barrel of oil?

Gas prices are very low, but not below zero. Gasoline prices are not the same thing as crude oil prices, which are not the same thing as the price of a contract to receive WTI next month. The price of crude oil is one factor among many that determine the price that we pay at the pump, a price that may very well fall even farther than it already has.

The retail price of gasoline is a combination of wholesale gasoline prices, refining and transportation costs, marketing costs, gas station markups and, of course, taxes. Even if all of these other components fell to zero, we know that taxes will not, ever. I am sorry to say it, but the price at the pump will remain positive despite the price of crude oil.

What we Think

Negative WTI futures are fun cocktail party conversation (remember those?), but the root is the decline in global demand. We have consistently sought to remind our clients that this crisis is distinct from previous crises due to its artificial origin. Businesses are closed and demand is down because of government policy, not because of a speculative bubble or a market failure. This is a deliberately engineered freeze. It will eventually thaw, and when it does "black gold" will remain a critical component of the world's economic growth.

We should not attempt to predict the future or time the markets. This includes rushing to buy oil stocks or ETFs due to a temporary distortion. We do not gamble in futures contracts for any commodities in our portfolios, nor do we expect to. We believe that long-term goals are best achieved with long-term investments, which exclude futures contracts.

The fact that short-term global demand for oil has fallen as a result of COVID-19 does not impact our core confidence in America, in global markets, and in capitalism to endure and thrive into the future. In our view, pursuing the long-term growth of markets – with a disciplined, diversified, and low-cost process - is far more important than chasing short-term variations in the price of Texas Tea.

(Y'all come back now, y'hear?)

Frank Hujsa, CFP®, CLU®

Partner, Acadium Financial Partners
27499 Riverview Center Blvd, Suite 108
Bonita Springs, FL 34134

Any opinions are those of Frank Hujsa are not necessarily those of Raymond James. Securities offered through Raymond James Financial Services, Inc. member FINRA/SIPC. Acadium Financial Partners is not a registered broker/dealer and is independent of Raymond James Financial Services. Investment Advisory Services offered through Raymond James Financial Services Advisors, Inc.

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. Investing in oil involves special risks, including the potential adverse effects of state and federal regulation and may not be suitable for all investors.