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Oil price crashes
WTI & ANS plummet into negative territory as May futures contract closes
Alan Bailey for Petroleum News
On Monday, April 20 the price of West Texas Intermediate crude oil fell into negative territory for the first time in history, as the COVID-19 pandemic decimated oil demand. At one time the WTI price dropped as low as -$40 per barrel. Essentially oil traders were willing to offer money to people willing to take oil off their hands. The Alaska Department of Revenue reported an Alaska North Slope crude price of -$2.68 at the close of the same trading day.
On April 12 the Organization of Petroleum Exporting Countries and Russia agreed to cut about 9.7 million barrels per day of production in May and June in response to the impact of the pandemic. The hope was that falling oil prices would also cause other non-OPEC production to fall, bringing the total production drop into line with reduced demand. However, concerns that the fall in supply would not be sufficient to accommodate the scale of the drop in demand now appear justified.
But although the price falls have been dramatic and unprecedented, reflecting serious woes for the oil market, the falls on April 20 were also related to technicalities in the way in which the oil market operates.
Benchmark crudes Crude oil prices are typically quoted with reference to specific benchmarks, in particular West Texas Intermediate, or WTI, and Brent Crude. The quoted prices normally reference prices in the futures market, the market whereby sellers and buyers commit to the sale of specific volumes of oil at a future date at an agreed price. Contracts work on a monthly basis, with different pricing for different months in the future. The futures market is complicated by the use of a system of trading derivatives: Traders and speculators buy and sell futures in hopes of making profits. There is even an oil futures exchange traded fund that is quoted on the stock market.
The WTI and Brent markets also operate in distinctly different environments. The sale point for WTI is Cushing, Oklahoma, where oil from various U.S. basins is delivered by pipeline. Brent oil is sold from the North Sea, with much of the oil being delivered by tanker to various destinations. While WTI oil delivery is constrained by the delivery capabilities through Cushing, and limited local oil storage capacity, Brent delivery via tankers to a variety of destinations can be more flexible. Consequently, with abundant supplies of U.S. oil, WTI tends to trade at a lower price than Brent.
In addition, while Brent futures contracts are settled in cash, a WTI contract has to be settled through the physical delivery of oil. And, in the current oversupply situation, there is a shortage of available crude oil storage capacity.
May futures crash April 20 was the last day of trading for the May futures contract for both WTI and Brent. And with a major oversupply of WTI oil, oil traders holding commitments to buy oil, became desperate to find people willing to commit to taking the oil. Ultimately traders started paying people to accept the oil, rather than become stuck with oil that they would then have to pay to deal with. Hence the negative pricing.
Meanwhile, although the Brent price also dropped, the more flexible distribution and storage options for this oil enable traders to continue to sell the oil, thus keeping the Brent price positive.
And, although the negative pricing for WTI conveys an important message about the state of the oil market, it is also important to place this market crash in perspective. While the trading volume for the WTI May futures contract was relatively light, the parallel trading for the June contract was heavier, with the June price remaining positive. Then, on April 21, as the June contract became the index price indicator, the WTI rebounded into positive pricing, albeit at the very low level of around $10. Brent was trading at $19. What will happen in the June futures market, going forward, remains to be seen.
Alaska North Slope crude So what does all of this mean for the price of Alaska North Slope crude, the price that underpins the Alaska oil industry?
Most ANS crude is sold into the U.S. West Coast market, a market that is physically and commercially separate from the WTI market and that does not have a futures or spot trading market. Petroleum economist Roger Marks told Petroleum News that back in the 1980s North Slope oil fully supplied the West Coast market. But, with the subsequent decline in North Slope oil production, more than half of the oil delivered to the West Coast is now imported, much of it from Saudi Arabia. And, with the recent shutdown of China in response to COVID-19, some additional Saudi oil has been diverted to the West Coast - this appears to be one reason for a sharp fall in West Coast oil prices, Marks said. Presumably ANS crude has to compete on price with imported oil.
However, integrated oil companies BP and ExxonMobil, rather than selling their oil on the West Coast, deliver their oil to their own refineries - there is no actual sale of the oil, Marks said. But it is important to realize that, with the slump in air and road transportation on the West Coast, the demand and prices for refinery products have slumped, regardless of what the feedstock crude oil costs and how much is available.
Other North Slope operators do actually sell their oil, either on the West Coast or to other producers who themselves deliver oil to the West Coast.
ANS pricing The Alaska Department of Revenue uses the prices at which North Slope producers sell their oil in particular as a key input to calculating the production taxes that the producers owe to the state. Dan Stickel, chief revenue economist for DOR, told Petroleum News that the North Slope oil that is sold in the West Coast market is typically sold under contract, with pricing for a specific volume of oil set at a specified differential from a benchmark price, typically either WTI or Brent. These contracts are normally established a couple of months in advance of the sale dates, Stickel said. Although at one point almost all ANS trades were being conducted relative to WTI, Brent is now being increasingly used. But ANS is currently being traded at a discount to both of these benchmarks, Stickel said.
However, the manner in which the ANS crude price seems at present to correspond more to WTI than to Brent appears to be more of a symptom of overall market volatility, rather than of ANS actually tracking WTI, he said.
To obtain an oil market price of general applicability in tax determinations, DOR determines what it refers to as the prevailing oil price. By regulation, the prevailing price is a monthly average of daily ANS prices assessed by Platts and Reuters, companies that are able to hear about contracts and deals that are being conducted in the West Coast oil trade, Stickel said. The department uses a similar procedure to obtain a daily ANS crude price for publication on its website.
Price remains low Although DOR published the negative price of -$2.68 for April 20, the department’s published price has been positive on other days, albeit at a low level. The ANS crude price was $9 on April 21, with WTI being $10 and Brent $19. On April 22 ANS had risen to $10, WTI to $13 and Brent to $20.
The ANS price is now well below the level required for profitability on the North Slope. Marks said that North Slope production had not yet started to drop but would likely do so if prices remain much below $30 - the oil companies will have to cut back on some capital spending and operating expenses. However, the price will recover when the world recovers from the pandemic, and it is likely that some tankers will head for China rather than the West Coast, as China starts to open up, Marks suggested.
The Department of Revenue has issued the following statement in response to the oil price situation: “The oil markets are experiencing an unprecedented market event, with robust supply and quickly filling storage happening at the same time that demand has fallen dramatically due to COVID-19. Prices have been volatile as the market digests this imbalance and likely will continue to be volatile. The negative WTI prices earlier this week were related to expiration of the futures contracts for May delivery. Impacts to Alaska of this particular low price will be based on average prices over the course of the month, and most deals being done for ANS crude are currently focused on June delivery, not May. However, the big picture fundamental drivers are absolutely concerning for Alaska - until there is a rebalancing of supply and demand globally we are likely to continue to see pressure on prices.”
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