For the first time in history, a barrel of West Texas oil was so worthless Monday that oil companies would pay you to take it. Oil prices have been low for months, but the negative pricing of a valuable commodity can be hard to wrap your head around. How does it happen?
A lot of it has to do with storage.
Oil prices collapsed this year because of a one-two punch: Oil-producing countries increased supply and COVID-19 destroyed demand.
Now oil companies are cutting production. But shutting down wells is costly, time consuming and can hurt long-term well productivity. No company wants to do it, and each company hopes its competitors do it first.
“In a lot of cases for a lot of these producers its almost better for them to sell oil at a loss than to stop producing because there’s some complications in getting restarted,” says Denton Cinquegrana, chief analyst with the Oil Price Information Service. “It’s good to have at least some money coming in than no money at all.”
That means companies haven’t been doing it fast enough, and there’s still way more oil being produced than there is demand.
When that happens, storage facilities start to fill up. In the U.S., storage space is starting to run out and not all oil producers have equal access to it.
So, when companies have oil, but no one to sell it to and nowhere to put it?
That’s when they start paying you to take it.
The negative pricing has been helped along by a deadline oil traders will hit Tuesday. After that, they can no longer sign contracts, known as “futures,” to deliver oil in May.
It’s important to remember oil is not expected to stay negative forever. Futures contracts for oil into the summer still have it trading in positive territory. When a commodity is worth more in the future than it is for immediate sale, the market condition is known as “contango.” That makes storage fill up even faster.
“August, September, October – if I can find storage and pay those monthly fees to sell the barrels, I could conceivably sell oil at a profitable level once we get to those months,” Cinquegrana says.
Once traditional storage tanks are filled, oil can also be stored in the vast salt caverns of the U.S. Strategic Petroleum Reserve or simply sit floating in ocean tankers.
By some estimates, the U.S. will run out of oil storage in May. Once that happens, companies have no choice but to shut in their wells. In Texas, that economic damage will extend also to state budgets, as oil and gas provide billions in tax revenue.