Forgive me if this is a stupid question but they can’t hold a gun to your head to force you to take the oil, right? Can’t you just refuse the delivery if you have nowhere to store it? Is there language in the contract for this kind of situation?
In this sense "barrel" is a unit of measure. The oil is physically in tanks in Oklahoma. When oil is delivered it stays in the same tank, but the ledger for the tank contents are updated.
Once delivery is made you are now on the hook for the storage costs - which are going sky high because there is no available storage inventory. You can default on your obligations to the storage company, but they will sell off whatever oil you hold to cover debts and then sue you for the rest.
When the market is functioning correctly you end up paying for a few days of storage while the oil is diverted to a pipeline where you can extract it, or it is offloaded on to your train/truck/tanker/etc.
That's not a stupid question it's an excellent one. If you don't take delivery you're in breach of contract. The penalties for that are going to depend on how the judicial process works out.
This has never happened before, so I don't know how it will play out other than that it's going to be wildly messy. Probably far messier than anyone, myself included, is imagining.
>That's not a stupid question it's an excellent one. If you don't take delivery you're in breach of contract. The penalties for that are going to depend on how the judicial process works out.
That sounds incorrect. The whole point of having standardized, commodified units trading on organized exchanges is that you don’t have to reinvent the dispute-resolution wheel — or turn it over to super slow courts — for every foreseeable thing that can go wrong. So there should be a specific procedure and penalty you can look up.
I asked the same question and got this answer that seems more correct and along the lines of my intuition, that the exchange holds it (or rather, directs others to home it) and bills your account for the cost:
The contract[1] assumes that Cushing has storage capacity. IANAL so I don't know how material that will be, but I continue to expect that lawyers will get involved and this will be a mess.
In an arrangement with the US Government it could be put into the ground, elsewhere. Doing it without state permission would be an entirely different matter however. I'm not aware of any very large, privately owned underground storage caverns (such that they could make a dent in absorbing the over-supply).
This is being discussed:
"The U.S. Energy Department is negotiating with nine companies to rent about 23 million barrels of oil storage capacity in its Strategic Petroleum Reserve as part of a Trump administration bid to help drain the country’s growing glut of crude."
Here is what the US Strategic Petroleum Reserve looks like (it can absorb some of our over-supply briefly):
> Four underground salt caverns on the coast of the Gulf of Mexico store the oil. That's a central location. The oil can be distributed to nearly half of the U.S. oil refineries either through interstate pipelines or via barges. It only takes 13 days for the oil to enter the U.S. market from the time the president first gives the order.
> There are two cavern locations in Texas. As of September 30, 2018, Bryan Mound held 235.3 million barrels in 20 caverns. Big Hill held 153.4 million barrels in 14 caverns. The other two are in Louisiana. West Hackberry held 199.5 million barrels in 22 caverns. Bayou Choctaw held 71.88 million barrels in 6 caverns.
> The maximum capacity of all four caverns is 727 million barrels.
Why should the American people pay to fill it when they can now be paid instead to store the oil? The market's decided that the toxic asset needs to go somewhere and the speculators that bought it (not the producers) will pay.
>The workaround is to cheaply rent out the reserve as storage space
Cheaply? They took a risk in speculating and it didn't work out. The solution is to give them a choice: surrender their oil to the USG (to avoid paying storage fees) or pay the USG for the service of storing it.
I can understand the impulse, and absent any middlemen it would make perfect sense to have the government step in to buy excess production during a crisis to fill national reserves.
But we have speculators who sold us the idea that their profits brought stability to the market, so make them keep playing by their own rules.
It's not a bailout. Prices were negative! We'd literally be _getting paid_ to take oil and put it into our reserve. It's literally the easiest financial decision on the planet.
The fact that Pelosi blocked it demonstrates a fundamental lack of understanding of basic finance.
Hm, I can't find any sources to this effect. Have one? I vaguely recall a bit about paying over market for petroleum to refill the reserve, with the idea being we fill a demand and prop up the gas industry.
The USG can top off the reserve at any time and it'd be chump change. They're spending trillions of dollars these days. They're not concerned with a few billion dollars worth of oil here and there.
I love this question! Mainly because first I laughed at "But that would be silly -- we spent all this effort taking it out of the ground", but on second thought it represents a reasonable thought of "We got it from the ground, therefore the ground isn't the worst place for this stuff maybe?".
Reconfiguring wells to reverse flow is a lot of work, and would take a significant amount of time to setup. This can happen with old gas wells, excess gas can be compressed and reinjected into the well, but they are specially designed systems.
This sort of refusal would likely has contractual penalties associated with it. Drillers and pipeline operators can't just shut down infrastructure by flipping a switch like it's nothing; it costs real money to perform shutdown procedures or restart pipeline pumps.
I bet all the lawyers who put such clauses in futures contracts are feeling pretty smug right now. I can imagine an oil producer going "Why on earth do we need to put this in the contract? Of course they'll accept delivery. If they don't then that's great for us."
That's actually a really good point. I've gone through plenty of contracts that are 20+ pages in length and wondered if they really need to be that long.
It's times like these that those contract clauses protect you, in a big way.
Eh, they probably thought it (however unlikely) could happen for reasons other than a pandemic. Like unprecedented green energy incentives leading to everyone suddenly driving an EV.
That example is a bit implausible. This is only a problem when oil prices fall very low very quickly. Manufacturing constraints prevent mass EV adoption on those timescales.
On the other hand, people who draft contracts for big corporations get to talk to risk analysts and ask "if we agree to this, what might go wrong that causes us to lose money?" and write clauses that generally protect them from that risk.
When it costs you nothing to add a clause to a contract, you don't need to come up with a plausible scenario for how something could happen, you only need to foresee the logical possibility of it occurring for any reason whatsoever. Part of managing risk is understanding the world is much more creative at coming up with failure scenarios than you are.
That sums up my intention. I shouldn't have provided an example, for precisely the reason you describe: it's not likely to be what causes the clause to be invoked.
Well, you'll be on the hook for the storage costs until you arrange somewhere for it to go, so in that sense, yes they can. Yeah, you can sell the oil to someone else in the future, but when? Meantime, you owe rent.
You are required to post cash collateral in order to take out a futures position. It's calibrated so that the cost of abandoning that collateral is large enough to basically be a gun to your head. Furthermore, when the price of the contract moves, they mark-to-market your collateral and credit/debit you your daily gains or losses.
Basically, the people holding the contracts have to either sell at a negative price to cover, pay to take delivery, or give up cash collateral that's worth even more money than the previous choices.
Rejecting delivery would be no different than any other contractual arrangement, like buying a car or selling stock. If you decide to not follow the contract, you'll be sued.
