Traders play ‘hot potato’ with U.S. oil contract as it crashes to $5 a barrel

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FILE PHOTO: A maze of crude oil pipes and valves is pictured during a tour by the Department of Energy at the Strategic Petroleum Reserve in Freeport
FILE PHOTO: A maze of crude oil pipes and valves is pictured during a tour by the Department of Energy at the Strategic Petroleum Reserve in Freeport, Texas, U.S. June 9, 2016. REUTERS/Richard Carson

April 20, 2020

By David Gaffen

(Reuters) – Energy traders bailed out of the expiring May U.S. oil futures contract in a frenzy on Monday, as the contract dropped by more than 70% to less than $5 a barrel and opening the widest gap ever between it and the next contract with storage rapidly filling.

That yawning gap <CLc1-CLc2> has opened because a glut of oil is heading towards the United States while demand has dropped by 30% due to the coronavirus pandemic. While oil-producing nations have agreed to cut output and major global oil companies are also trimming production, those cuts will not come quickly enough to avoid a massive clog in the next couple of weeks.

As a result, futures traders, who would normally be able to shift from the expiring contract to the next, are finding few buyers for the expiring May contract to take delivery of barrels. As more traders dump the May contract <CLc1>, it has crashed, lately trading at $8 a barrel.

“The cavalry (OPEC-plus cuts) won’t arrive in time to save this oil market. This may prove to be one of the worst deliveries in history. Nobody wants or is in need of oil right now,” said Phil Flynn, senior market analyst at Price Futures Group in Chicago.

As of 12:57 p.m. ET (1657 GMT), the May contract <CLc1> was down $13.23 at $5.04 a barrel, or 72%, at one point falling as far as $4.04 a barrel. Notably, just 107,000 contracts had changed hands. By contrast, the June contract <CLc2> was down $2.72, or 11%, to $22.26 a barrel, but had more than 758,000 contracts traded. (Graphic – Oil contract gap: https://reut.rs/3eBfgPy)

When a futures contract expires, traders must decide whether to take delivery or roll their positions into an upcoming contract. Usually this process is relatively uncomplicated, but the May contract’s decline reflects worries that too much supply could hit the markets, with shipments out of OPEC nations like Saudi Arabia booked in March set to cause a glut.

Available storage space is dropping fast at the Cushing, Oklahoma hub, where physical delivery of U.S. oil barrels bought in the futures market takes place. Four weeks ago, the storage hub was half full – now it is 69% full, according to U.S. Energy Department data.

“It’s clear that Cushing is going to fill and it will stay full for the next several months,” said Andy Lipow of Lipow Oil Associates. “Because producers have been lagging in their production cuts we’re seeing an overwhelming amount of crude oil looking for a place to go around the world.”

Crude stockpiles at Cushing rose 9% in the week to April 17, totaling around 61 million barrels, market analysts said, citing a Monday report from Genscape.

The world’s major oil producers agreed to cut production by 9.7 million bpd in an attempt to get world supply under control as demand slumps, but those cuts do not begin until May. Saudi Arabia is ramping up deliveries of oil, including big shipments to the United States.

Worldwide oil consumption is roughly 100 million barrels a day, and supply generally stays in line with that. But consumption is down about 30% globally, and the cuts so far are far less.

U.S. exchange-traded funds are also playing a role in the action, analysts said. The U.S. Oil Fund LP <USO.N>, the largest crude oil ETF, said on Thursday that it would start moving some of its assets into later-dated contracts earlier in the life of the monthly contract.

Graphic – Oil contract gap: https://fingfx.thomsonreuters.com/gfx/editorcharts/xklpyylgpgd/index.html

(Reporting by David Gaffen; Editing by Nick Zieminski, David Gregorio and Lisa Shumaker)

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