A plunge in U.S. crude oil prices this week reverberated across global financial markets and fueled renewed worries over the beleaguered shale oil industry. Yet billionaire investor Howard Marks isn’t panicking.
Marks, who co-founded Oaktree Capital Management, told CNBC in an email interview that the weakness in crude oil prices was steeped in fundamentals as energy demand has cratered due to the coronavirus pandemic and buyers are scrambling to stockpile crude oil due to storage space becoming scarce.
“It’s not a panic. The move is completely rational,” Marks told CNBC in an emailed statement.
“The ultimate complication is that storing oil costs money, and storage facilities aren’t unlimited. Right now storage is scarce and thus expensive, so it’s not worth it to buy oil today and store it. The cost of storing exceeds the value today; thus the price is negative,” Marks said.
The comments from Marks come after West Texas Intermediate crude for May delivery fell more than 100% to settle at negative $37.63 per barrel on Monday, which meant that traders were effectively having to pay to get oil taken off their hands. That marked the first time that the price of an oil futures contract had turned negative.
The May WTI contract, which expired on Tuesday, settled at $10.01 a barrel. Futures contracts trade by the month.
The June contract is currently trading around $11 per barrel. Meanwhile, international benchmark Brent crude stood at $17.01, nearly 12% lower.
The coronavirus pandemic has dealt a severe blow to economic activity around the globe and sapped demand for oil. While OPEC and its oil-producing allies finalized a historic agreement earlier this month to cut production by 9.7 million barrels per day beginning May 1, experts reckon that the reduction in supply won’t be enough to offset the diminution in demand.
The International Energy Agency, for instance, warned in its closely-watched monthly report, that demand in April could be 29 million barrels per day lower than a year ago, hitting a level last seen in 1995.
“Oil production can’t just be turned off, because for production some wells depend on pressure that a shut-off complicates. So, oil is coming out of the ground that exceeds the amount needed for consumption,” Marks said.
The gloominess in the oil market has also put the spotlight on US shale oil producers that are grappling with feeble demand on one hand and a lack of storage on the other, a conundrum that is making desperate oil companies “pay” traders for taking oil off them.
However, there are potential signs of relief. Some far-dated contracts this year are showing average oil prices of $20 a barrel and above while contracts expiring in 2021 are reflecting a modest bounce in demand taking prices to near $30 per barrel. Marks spotted a semblance of rationality in those prices.
“Oil can be bought for delivery by month. The negative price for oil reflects the excess of supply over demand, plus the cost of storage. The price for oil in future months (when consumption may have rebounded) is at more normal levels,” he said.