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Oil Going Nowhere

I have to agree with former Sen. Robert Torricelli, the New Jersey Democrat credited with having said that if you live long enough you’ll experience everything. But I’ll bet neither of us ever expected to see oil prices quoted with a minus sign.

The price of oil – or, more specifically, the price of a prominent oil futures contract – went deep into negative territory this week, a place nobody ever thought it could go. It went there because Americans and most of the rest of the world are going nowhere these days amid the coronavirus-fighting lockdown. Meanwhile, oil wells continue to pump crude, for which there is an ever-diminishing appetite at refineries. The oil that is coming out of the ground has no place to go except into storage, where available space is rapidly shrinking.

Torricelli is a few years older than I am. Both of us are baby boomers who came of age amid the oil supply shocks of the 1970s that produced soaring prices and, in New Jersey and many other places, long lines of drivers waiting to fill their cars at gas pumps. That is a sight today’s young people might not ever expect to see, although it is anyone’s guess what they will see if they live long enough.

Despite the headlines about negative oil prices, it is doubtful that many oil producers – if any – actually paid cash money this week to have someone take their product. While some oil is sold as it is pumped at “spot” prices, much of it is sold ahead of time via contracts that require the holder to take delivery of a specified quantity of crude at a specified time and place. Like the futures contract, the spot price varies according to the time and place of delivery, and the grade of crude being delivered.

On Monday, I watched my screen in fascination as the contract price for May delivery of West Texas Intermediate crude – the benchmark grade that is pumped in the Permian Basin and usually delivered to storage in Cushing, Oklahoma, or to refineries on the Gulf Coast – dropped from around $15 per barrel as I ate breakfast to the negative-30s after lunch. It ended the day at negative $37.63. But what does this mean?

Let me construct an analogy. It won’t be as memorable as the scenes featuring Margot Robbie, Selena Gomez and Anthony Bourdain in “The Big Short,” in which they explain collateralized debt instruments and derivative contracts. (You really don’t want to see me sip champagne in a bubble bath anyway.) But I will credit them with the inspiration.

Let’s imagine three New Yorkers named Andrew, Bill and Donald. Andrew opens a car wash with the latest high-tech car washing machinery. It will be profitable if he can keep it full of cars each day at a price of $10 per wash. At that price, he will break even on the wash and make his money selling snacks and air fresheners to drivers while they wait for their vehicles.

Bill believes a clean car in his city is worth more than $10. So he signs a contract with Andrew in which he agrees to fill all Andrew’s slots on a particular day for $10 per slot. The contract stipulates that for each unused slot, Bill must pay Andrew $20, in consideration of Andrew’s lost profit from the ancillary snack sales. Bill knows Andrew doesn’t like him, and will stick it to him at the first opportunity, but Bill figures he can sell all Andrew’s slots and avoid any problems.

But then a pandemic hits. Hardly anyone drives, so hardly anybody’s car gets dirty. Nobody wants to pay Bill a premium to get their car washed. In fact, nobody even wants to pay $10. Bill is worried about how he will fill the slots he promised Andrew he would fill. So Bill calls Donald, a businessman who considers himself quite the deal-maker.

Bill offers to sell Donald the contract for $10 per slot. Donald isn’t interested. Bill then lowers his price to $5 a slot. Donald still isn’t interested. Bill, getting desperate, tells Donald he can have the contract for free. Bill will lose all the money he paid Andrew upfront – $10 per slot – but he won’t lose more money in the future. But Donald knows a vulnerable counterparty when he sees one. He offers to take the contract off Bill’s hands, but only at a price. Bill is shocked and horrified, but he faces a choice between paying Donald now or paying Andrew $20 per slot when the contract comes due.

You can see why Bill might be willing to pay Donald anything up to $20 per slot, since it means he is no longer in Andrew’s power. If Donald offers easier payment terms and Bill is really strapped for cash, he might even pay Donald more than the $20 per slot penalty rate he would owe Andrew. Andrew, while always interested in torturing Bill, wants to stay on good terms with Donald.

Why would Donald take the contract at any price below the $20 per slot he might end up owing Andrew? There could be valid reasons. Donald might have his own collection of cars, which he can use to fill Andrew’s slots without buying a single air freshener. Maybe Donald has control over a strategic reserve fleet of vehicles he can wash at Andrew’s facility. Or he might be confident that he can stimulate demand for car washes by paying drivers to get their cars washed. Getting paid to have your car washed is no crazier than getting paid to take somebody’s crude oil.

How does all this relate to the contract for May delivery of WTI crude? Simply, anyone who had a place to park the contracted amount of crude oil could have been willing, at the right price, to take the obligation to accept that crude off the hands of someone who lacked capacity to fulfill it.

This is all a result of the pandemic’s temporary destruction of the supply-demand balance that governs daily life. Much of the world’s oil is used in transportation. Despite the needs of the food and medical supply chains that are keeping most of us fed and healthy, there is strikingly little transportation happening right now.

Last Saturday I drove on the New Jersey Turnpike past Newark International Airport, one of the New York City metropolitan area’s major gateways. In normal times the terminals are crowded with everything from twin-aisle jumbos to smallish regional turboprops. A steady lineup of planes land and take off from runways that are parallel to the highway.

This time I spotted just two jets parked at the passenger terminals. I couldn’t see a single plane on the runways or taxiways, or in the air on final approach. United Airlines, which has a major hub at Newark, has cut daily departures from more than 100 to about 15. Other domestic lines have made similarly proportionate cuts. Many foreign carriers are not flying there at all.

The Turnpike itself has six lanes in each direction where it passes the airport, with a three-lane roadway set aside for passenger cars and the other three open to trucks and buses as well as private vehicles. I always drive in the truck lanes. Despite the usually heavy traffic of big rigs, the commercial drivers are less accident-prone than the amateurs, who often tie up the dedicated car lanes with fender-benders and more serious wrecks. This past Saturday, however, as I ferried groceries to my 93-year-old mother farther south in New Jersey, I saw almost no trucks on the Turnpike, just as there were no airplanes active at Newark.

One New Jersey columnist reported last week that he saw a goose walking on a major highway at rush hour just outside New York City; that same outlet reported Turnpike traffic is down by two-thirds. On the New York side of the Hudson River, subway and commuter rail passenger counts are down by as much as 97%. Nearly 80 workers at the Metropolitan Transportation Authority have died of COVID-19.

Far from the center of the national COVID-19 crisis in the New York metropolitan area, the Tulsa World reported that traffic through that city’s airport security screening checkpoints was down 96% from a year earlier on April 8. Similar traffic declines have happened all over the world. In southern Africa, air travel has essentially stopped, according to the German news outlet Deutsche Welle (DW).

The highly abnormal behavior in the oil futures market is a consequence of the highly abnormal times in which we live. One day things will be normal again, and younger generations will find it hard to believe that the price of oil could ever have been negative. But if they live long enough, they’ll see everything, too.

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