- Brent Oil Futures allows cash settlements
- Brent offers easy access to ports, WTI landlocked
US Crude went negative for the first time in History
Yesterday saw the biggest bloodbath in oil market as the US Crude May futures went as low as -$40.32 per barrel from around $18 dollars on Friday. On the other hand, Brent oil contracts contracted only 8% to 9% and remained around $20-$21 per barrel.
The most anticipated OPEC deal which finalized last week could not save oil from crashing. Given the spread of pandemic and maintained lockdowns, the inability of OPEC to secure oil industry is not shocking.
Read More: How OPEC deal fails to benefit oil Industry
The main reasons attributed to this crash in WTI prices is over supply in the market. Also there is limited storage capacity for oil buyers. As the futures contracts for WTI was expiring yesterday, the investors panicked. Due to their inability to receive physical delivery of WTI and sold May contracts in huge losses.
At the same time Brent oil May futures that are expiring on 25th April, witnessed considerably lesser movement. There are fundamental reasons for this difference in behavior of both commodity prices. The future contract specs specifically delivery conditions, area of production and storage capacity of investors are three main factors that resulted in shocks to WTI while Brent survived.
Let’s look at some basic facts regarding WTI and Brent Oil and their futures contracts.
Where does WTI and Brent Oil mainly come from?
West Texas Intermediate (WTI) crude is extracted by US exploration companies in Texas. The oil is passed through pipelines and refined in Midwest and Gulf of Mexico. Finally the delivery and price settlements take place at Cushing, Oklahoma.
Brent Oil on the other hand, is extracted at North Sea. It is produced by Europe, Africa and Middle East. The Brent oil is produced in areas that are mainly near ports unlike WTI production that is landlocked.
How Delivery and Transportation of Oil benefits Brent Oil?
Due to the bang in US shale, production of WTI is higher than Brent and thus, prices for WTI are lower than Brent while supply is high. Still Brent oil comprises of two-third of world supply due to demand for its specific quality. Moreover, depth of oil and distance from land contribute significantly to demand and price of oil commodities.
The transportation of oil deliveries from landlocked Cushing is a major hindrance in US capturing great market share than Brent. Brent oil on the other hand has easy access to different ports and is flexible in delivering to various storage capacities.
WTI and Brent Futures Contract Specs
The specification of futures contracts for both WTI and Brent played a significant role in why the commodities behaved differently yesterday. Brent oil futures are traded on Intercontinental Exchange and New York Mercantile Exchange (NYMEX). WTI future contracts are traded on NYMEX. Settlement of futures contracts for WTI and Brent oil is a major factor that created panic in oil market last night.
The WTI futures contract are settled by physical delivery while Brent oil is financially settled. Therefore, if investors are unable to reach their storage capacities amid lockdown or have low capacity due to falling demand of oil, then they cannot take physical delivery and are bound to sell contracts in losses. Moreover, the price speculators can hold contracts until delivery without any pressure to sell them in loss.
Lack of Storage Capacity resulted in Panic Selling
May futures contract reached its expiry yesterday but the world oil storage capacity is less than 40% now. US Energy Information Administration (UEIA) last week revealed that Cushing, Oklahoma has now storage capacity of less than 25%. Cushing is the main storage point for WTI where deliveries for futures contracts are taken. Moreover, the delivery of WTI has become impossible with most of the areas under lockdown restricting transportation. All types of transportation is restricted under the lockdown and Cushing is already a landlocked area. Due to these stats, the investors for WTI futures contracts started selling their contracts in a haste. This resulted in excessive selling and crahsed prices for WTI.
The sellers continued up to the point where value of WTI future contract became negative. The investors preferred to sell May contracts and bought June contracts in anticipation of ease in lockdown worldwide by next month.
Brent Oil contracts on the other hand, have a different delivery date. The flexibility in contract specs of Brent can save it the same fate as WTI. The Brent contracts allow cash settlements which will help in avoiding any panic. Moreover, due to the location benefits of Brent oil production in Europe, Middle East and Africa, it can be delivered offshore to any storage capacity. Brent extracts oil from a large number of fields in North Sea and can be stored in tankers. The buyers have a number of options for receiving delivery and thus, can buy more time for storing oil.
Ease in Lock-down can positively affect WTI and Brent
After the expiration of May contracts, WTI is again trading in the positive zone. Brent oil is trading around similar price range. Many countries from developed world have announced that they are considering ease in lock-down as the world enters fifth month of this pandemic. Germany, UK and U.S. will witness more ease in lock-down. New Zealand, UAE and many other countries will be lifting restrictions in specific sectors only.
The ease in lock-down at any level suggests start of economic activity at some level. Any economic activity will be perceived positively by oil investors. The opening of Industrial sector or transportation will increase demand for oil. However, the large gap between supply and demand will continue to affect prices.