The price of crude oil has to drop pretty darn low for me to think about taking physical delivery, not least because I don’t own a refinery to turn the stuff into anything useful, like gasoline. But when the price hit negative $37 in futures trading on April 20 , I started brainstorming.
I can probably fit 10 barrels in the garage, between the lawn mower and the emergency cache of Campbell’s SpaghettiOs With Meatballs. I can lay out another 90 in the backyard and call it an obstacle course for the kids. That’s $3,700 just for taking the barrels, and if September futures are any indication, I might pocket another $2,600 for delivering my oil to a buyer in late summer.
But it turns out that it doesn’t work that way . For one thing, even though oil is quoted in dollars per barrel, sellers don’t throw in the barrels with the oil. You can’t even bring your own. Futures are finicky like that.
The contract that went sharply negative was for May delivery of what’s called West Texas Intermediate—a lovely crude that is both light and sweet, which is to say, low in density and sulfur. It has to be delivered through a cramped facility in a small Oklahoma town called Cushing.
“You have to have an agreement with the pipeline to bring it into the tank farm,” explains Scott Schnipper, global head of FX, commodities, and rates at J.P. Morgan Private Bank. “And it has to be approved ahead of time.”
Most WTI futures buyers aim to sell their contracts at a profit before expiration—April 21, in the case of the contract for May delivery. But Cushing is stuffed. So May contracts with no storage lined up had to be dumped near the close of trading on April 20. The exchange had only recently introduced a mechanism for negative trading. When a rush of sellers met no buyers, pricing briefly went bonkers.
Could it happen again when the June contract approaches expiration? “Definitely possible, but it’s not my base case,” Schnipper says. Commodity players have a strong incentive to find ways to free up storage, he says.
I’ll tell you who’s fine with that: Kenneth Hvid (pronounced “vid”), who runs Teekay Tankers (TNK). “Historically, you’re always using crude oil tankers from time to time to store oil,” he says. “That is typically increasing when you see contango in the oil market , where the future price is higher than the current. Then it makes sense for traders to store the oil and take delivery later.”
Hvid says that under normal circumstances, 5% of the global fleet is used for storage, but that’s around 30% now, and rates are plump. See, the coronavirus pandemic has gut-punched the economy, and with it, oil demand, but the outbreak is expected to abate. That’s why that WTI contract for June delivery was recently trading around just $15, but the September one was $26. Hvid says Teekay is making out so well on storage that its annualized free cash flow might be running at $650 million now, up from about $400 million during the fourth quarter.
For context, Teekay recently had a stock market value of $822 million. Long-term debt and other obligations, net of cash, stood at $844 million at the end of 2019. “A lot of tanker stocks have been trading at a discount to the [asset] value,” Hvid says. “It’s obviously taking a bit of time for the market to fully understand how to value a business which has gone from just covering its operating costs and finance costs to suddenly generating this type of surplus cash flow.” Teekay stock started the year at $24, fell to $12, and has rebounded to $24.
Tankers are among the only things in the energy sector not tanking. Before making a contrarian bet on something else that is heavily marked down, like a driller, investors should carefully consider the outlook for supply and demand .
For a read on demand, I spoke with Deutsche Bank’s chief economist, Torsten Sløk. He points out that 40% of oil is used for fuel for cars and trucks, so the road to recovery needs more traffic. Driving will increase gradually, Sløk says, because some workers will remain at home. “The second half of May and going into June, we should see a more significant increase in demand for oil,” he says.
For now, low oil prices are a worrisome sign for energy-sector jobs. Once driving picks up, consumers will save money, because gasoline prices are slumping with crude. Sløk says an oil price decline in 2015 and 2016 demonstrated that the pain in the energy sector is concentrated in states like Texas and Oklahoma, whereas the boost for consumers is felt more broadly.
“If you think about how diversified the U.S. economy is, the net effect of lower oil prices will continue to be positive overall,” he says.
When it comes to supply, a fracking boom has boosted U.S. production to the point where the country briefly overtook Saudi Arabia last year as the world’s top oil exporter. But Saudi Arabia and Russia share the blame for a production glut going into the pandemic. Saudi Arabia wanted to cut output, says Helima Croft, RBC Capital Markets global head of commodity strategy. But Russia balked.
So the Saudis instead cut their selling price and ramped up production. “What the Saudis were looking to do was essentially drive Russia back to the negotiating table,” Croft says. It worked, and the two countries agreed on April 12 to cut output by nearly 10 million barrels a day. “The question is, was it too little, too late?” she says.
The U.S. doesn’t decide production at a national level, so output cuts here take time. Bottom line: The market could stay oversupplied for longer.
For stock buyers who can’t resist the reduced prices, Devin McDermott, commodities strategist at Morgan Stanley, recommends a defensive approach in North America, with a focus on asset quality, balance sheet strength, and scale.
Among integrated giants, he has an Overweight rating on Chevron (CVX), down 30% this year. Among companies more focused on exploration and production, he likes ConocoPhillips (COP), down 46%; Noble Energy (NBL), down 71%; and Hess (HES), down 41%.
As for me, I’ll be interested to see whether that June WTI contract goes negative closer to expiration, even if I don’t have a way to profit because of that no-barrels-allowed nonsense in the fine print. I’ll tell you one thing: If SpaghettiOs ever go into contango, I plan to make a major move.
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