Why oil prices went negative and why they can go negative again

Geology is the study of pressure and time.  That’s all it takes really… pressure… and time.

Red Redding

“The Shawshank Redemption”

 Pressure.  Time.  And a big gosh darn supertanker.

Apologies for altering one of Morgan Freeman’s most famous lines in movies, but it had to be done to fit the oil drama that’s playing out with a Hollywood script.

The investing world was gobsmacked and eyes glued to CNBC when oil futures went negative last week.  If you missed it the first time, don’t worry it could happen again. 

Oil storage around the world is filling up, fast.  Onshore tanks in most parts of the U.S. are at capacity, and the rest of the world isn’t far behind. Desperate traders and producers are using any resource to store their crude.

Oil tankers sit anchored off the coast of Long Beach, California, U.S., on Wednesday, April 22, 2020. Almost three dozen ships — scattered in waters from Long Beach to the San Francisco Bay — are mostly acting as floating storage for oil that’s going unused as the coronavirus pandemic shutters businesses and takes drivers off the road.

Tim Rue | Bloomberg via Getty Images

Oil supertankers are looking like petroleum paparazzi, crowding the Los Angeles shoreline, either as floating storage or waiting on some kind of turn in sentiment.  With prices higher in coming months, for now it pays to sit on oil and hope to sell it for more money down the pipeline. 

Hope is a good thing.  Maybe the best of things.

The OPEC+ and G20 production cuts begin Friday, May 1st.  But there’s already an armada of oil tankers heading our way right now, ready to give us 40+ million more barrels of oil no one needs.  Much of that will go to the Saudi Aramco-owned Motiva refinery in Texas, but overall refinery output is already down to 67% and may get cut further because no one is driving.  

If refineries ultimately don’t want oil, it has little to no value.  If you have oil and nowhere to put it, it can have negative value.

The key question right now is how much time is left until everything is full: every tank, every ship, every hole in the ground?   

Depending on whom you ask, it’s anywhere from two weeks to maybe two months, best case.  Oil industry infrastructure is large and labyrinthine, and full of smart, creative people who may be able to extend current capacity through human ingenuity, thus postponing what no one previously could even dream of: nowhere to go, and negative prices. The industry is under pressure like never before.

 Pressure.  And time.

Absent a sharp demand return, production will need to be reduced more rapidly than what’s happening now.  Though only a few weeks into the first round of capital spending cuts, U.S. producers may have to cut again, and soon.   

Even long time oil folks, cynical yet optimistic as they are, understand what to do: Don’t take oil out of the ground if you have no place to put it and no one to sell it to. 

The industry is facing unprecedented demand, job and wealth destruction.  Yet some continue to pay for the same barrel of oil three times. They spend to take it out of the ground, spend to move it somewhere else,  and spend to store it somewhere, perhaps even back in the ground.

 It has to stop or the industry will. 

And to anyone who can’t see that, Andy Dufresne would have a simple question: how could you be so obtuse?

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