While the International Monetary Fund is busily warning of the worst economic slump since the Great Depression of the 1930s, the S&P 500 is, as we write, back above its levels at the beginning of 2019.

Against a backdrop of global stocks enjoying something of a recovery, the oil market is in a state of collapse with the US benchmark WTI falling to its lowest levels since 1999.

Interestingly oil prices were a canary in the coalmine for the big market sell-off which culminated in late March having fallen dramatically earlier in the year.

You may wonder if WTI’s dive to its lowest levels on record at minus $40 per barrel is another example of oil sounding a warning signal for other asset classes.

There are different factors at work here – fundamental supply and demand issues are impacting oil prices across the board, not just WTI.

Saudi Arabia’s aborted price war with Russia and ineffective attempt to row back by introducing production cuts has contributed to weakness in Brent crude – the main yardstick outside the US – too.

Demand has fallen off a cliff thanks to lockdown conditions which means people are not flying anywhere, they are driving much less, and fewer factories are running.

WHAT IS GOING ON?

What is different with WTI is the limited capacity to store the oil that nobody is currently using.

The US market has a significant degree of reliance on a key infrastructure hub in Cushing, Oklahoma. In a three-week period to 10 April, this went from 49% to 69% of capacity. In comparison, Brent is a waterborne market and it doesn’t have the same storage constraints as WTI.

The extreme nature of the price action in WTI was in the May contract which expired on 21 April. Oil is traded in futures contracts where the purchase or sale of a barrel of oil is agreed at a fixed price for delivery on a specified date.

Many traders buy these contracts with no intention of taking actual delivery of the oil – the plan being to sell the contract with the aim of booking a profit or roll over by buying the next contract.

However, with the aforementioned constraints on capacity to store the oil and pretty much zero demand for physical delivery, holders of the May futures contracts were effectively forced to pay others to take the oil off their hands.

Unless we are in a very different place this time next month, then we could be looking at a similar situation with WTI prices taking a dive once again.

When economic activity picks up a lower oil price could drive good news as it flows through to lower costs for consumers and businesses. However, in this scenario oil might not remain depressed for long.

Hedge fund Westbeck Capital Management, which has been shorting US shale producers, reckons there could eventually be a potential surge back even to $100 per barrel when demand returns. Some production lost in the current maelstrom might not coming back quickly, if at all, thus driving up prices.

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