Analysis: Cushing WTI price rout leaves US crude benchmark reeling

Houston — The oil hub of Cushing, Oklahoma, has overcome times of stress before without losing its prime role in US oil pricing, but on Monday NYMEX crude oil futures plunged headlong into uncharted waters, playing host to a scarcely believable sequence of trading and making the concept of negative commodity pricing a stark reality.

Although it later rebounded back into positive territory, the unprecedented move highlights like never before the potential difficulties of using Cushing -- the delivery point of the NYMEX contract -- as a pricing benchmark for oil trade in other US markets and beyond.

With little over a day to go before expiry, the CME Group's front-month May NYMEX light, sweet crude futures contract started nosediving, dropping below $10/b at around noon in New York. Two hours later, it fell below zero, trading at a negative price. The descent accelerated, and less than 30 minutes later it traded as low as minus $40.32/b, then settled at minus $37.63/b.

It's not unheard of for commodities to trade at negative prices, but for it to happen to crude at Cushing is exceptional. Negative prices have been seen only rarely -- and not usually for long -- with examples from recent years including cases such as associated gas in far western Texas or even very light natural gas liquids in Western Canada. In both cases, the commodity in question was an unwanted byproduct alongside more valuable crude, and had to be sold even at a negative price in order to keep the more valuable oil flowing.

But this is not what happened on Monday at Cushing. This was the benchmark itself, the commodity that was supposed to be the valuable thing, plunging deep into negative territory.

Cushing is something of an outlier among the major oil benchmarks, as it is not particularly close to either major production or consumption areas. What it does have is a lot of physical infrastructure, with a wealth of pipeline connections and a commercial crude storage capacity that is unrivalled.

By comparison, North Sea Brent crude, widely used as a benchmark in Europe and in markets around the world, is based on trade of physical waterborne cargoes of five different crude grades. While Brent's nominal storage capacity is lower than WTI at Cushing, it is intrinsically linked to the global market, with the crude making up the Dated Brent benchmark easily deliverable by tanker to refiners in any continent.

At Cushing, if you buy oil, you need a storage tank to put it in, and for several weeks now, that storage has been getting steadily more full. The scale and speed of the precipitous drop in oil demand has left the market incredibly oversupplied, and despite the best efforts of producing countries, that oversupply is weighing heavily on prices.

On Monday, only one day before the May contract expiry, time was running out for anyone still needing to sell crude. This futures contract is physically settled, meaning that any company holding open interest into the expiry has to take physical delivery of the crude, and needs a storage tank to put it in.

It's not yet clear exactly which companies were so desperate to close their long positions that they were willing to pay $20, $30, even $40 to take each barrel off their hands -- a consequence of market forces playing out in extremely stressed conditions.

FAR REACHING IMPLICATIONS

If this scarcely believable turn of events were confined to one small town in Oklahoma, it would still be a fascinating example of the power of those forces, but the fallout goes much farther than this. Traders of other crude grades in other locations, notably the large US Gulf Coast market built around Texas and Louisiana, typically buy and sell oil at a differential to Cushing.

In normal times, one could argue that this serves them well, with these differential markets reflecting the Gulf Coast fundamentals of a specific grade while the link to Cushing ensures that the final price reflects the overall value of the oil. In this way, they rely on Cushing to act as a general barometer for world oil prices, and fine-tune the price via the differentials. But this mechanism breaks down when the reference price at its heart behaves as it did on Monday.

In normal times, a seller willing to offer the Midland grade crude at the Magellan East Houston terminal would do so at a premium of a few dollars to Cushing. In fact, earlier on Monday, before the May contract went into freefall, there was trade reported in this MEH market at May WTI plus $7/b. But when Cushing then crashes into negative territory and settles where it did at minus $37.63/b, would it mean that MEH crude in Houston is really only worth $7/b more than this, which would still be below minus $30/b.

Similar questions should be asked about the market value of other Gulf Coast grades such as Mars or LLS, WTI cargoes being traded for export, or even crude loading in Latin America. Everything is weak right now, but that doesn't mean everything is going to march down in lockstep with the May Cushing contract. Other major benchmarks such as Platts Dubai and Dated Brent, for example, show no signs yet of falling into negative territory.

One big problem for US traders now is how to price their crude if they cannot rely on prompt Cushing prices as a stable benchmark. Do they move to a further-forward Calendar Month Average basis such as that used in Canada? Or perhaps, switch to a different benchmark altogether like Brent? Or ride out the storm until the May trade rolls into June and hope that the extreme volatility is not repeated next month?

With the oil market reeling from the impact of the coronavirus outbreak, perhaps the last thing US traders wanted was a fundamental doubt to emerge over their preferred pricing benchmark. But that's exactly what they've now got.