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Why Oil Prices Fell Below Zero: All You Need To Know

Professor of Financial Economics and Part-time Value Investor, Transfin.
Apr 21, 2020 5:53 AM 4 min read
Editorial

Oil prices have fallen sharply in the past few hours. A Futures contract for West Texas Intermediate (WTI) crude, the main US oil benchmark, fell more than $50 a barrel to end the day at $30 below zero, meaning WTI crude oil prices have gone negative for the first time since it began trading. While the sharp decline in the price can largely be explained by the slump in the WTI May Futures contract (set to expire on April 21st), the fall of over 300% nonetheless reflects the fastest and furthest fall in oil prices since records began in 1946.

 

 

What are Crude Oil Futures?

 

The anomalous slide in WTI crude is partly due to a technicality of the oil market – oil is traded in futures contracts.

 

Crude oil futures are contracts between buyers and sellers of oil wherein they agree to deliver certain amounts of physical crude oil at a given date in the future (which can be months or even years later). A futures contract is for 1,000 barrels of crude, and each contract trades for a month.

 

The benchmark futures contract for oil trading in the US involves WTI crude. Globally, the major benchmark is Brent crude, a certain grade mined in the North Sea off the Europen coast. There are other different types of Crude oil which comprises International oil markets. 

 

Oil Prices Less than Zero: What Does Negative Oil Price Mean?

 

The WTI oil futures contracts for May were due to expire on Tuesday (April 21st). And traders were reluctant to take delivery of oil and incur storage costs at a time when demand has collapsed because, well, nobody’s flying in airplanes or driving cars these days if you haven’t noticed.

 

(And no, this doesn’t mean petrol / gas stations will pay you money to buy oil - considering there are many other costs and taxes which are incurred before the petrol reaches you at the station)

 

So WTI futures won’t be actively traded. And the contracts for June and July are still trading higher, albeit in the low $20s. And Brent crude is still trading in the mid-$20s (at least as of 10 am, April 21st).

 

But what has happened also reflects wider market sentiment. The price of crude doesn’t only help investors gauge the prospects of other energy-related commodities like natural gas and petroleum; it also sheds light on equities, bonds and the economy as a whole. And the current outlook is evidently bleak and unconfident, or more so than expected.

 

Why Did US Oil Fall Below Zero?

 

Three main reasons – collapse in demand, continued supply and dwindling storage space.

 

The first one is obvious: the COVID-19 pandemic has shut down the world. Flights, trains, cars, bikes, ships have all been grounded, so there’s not much demand for crude right now. And even in the weeks to come, recovery is expected to be slow and cautious.

 

Meanwhile, supply has continued. After all, oil wells can’t be turned “on” and “off” whenever necessary without incurring heavy losses. They need to keep pumping out oil. And presently, it is cheaper for oil companies to pay traders to buy oil rather than to turn off drilling and restart it later.

 

The third reason is that storage tanks for WTI are becoming full because consumers aren’t buying oil – and it’s difficult to find alternate space. The US Energy Information Administration said last week that storage at Cushing, Oklahoma, the heart of the US pipeline network, was about 72% full as of April 10th.

 

The OPEC+ Angle

 

While Brent is still trading in positive territory, oil producers other than the US could be staring at a tumultuous future too.

 

OPEC, in particular, must be red-faced right now. Led by Saudi Arabia, OPEC had signed a deal with Russia and the US recently to facilitate a global oil production cut by almost 10m barrels per day (bpd), a number unprecedented in history. The 24-member coalition, referred to as OPEC+, hoped that this would improve oil prices at a time when prices were touching record lows.

 

But merely a week later, analysts’ fears that the production cuts were too little and too low seem to have come true. It was inevitable that oil prices would suffer the brunt of the COVID-19 pandemic, but the situation was aggravated by the Saudi-Russian price feud, which saw crude overproduction by almost 20m bpd until merely weeks ago. In the absence of this price war, storage facilities might have been less saturated and supply might have been more controlled.

 

FIN.

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