Negative oil price: What it means for you and me.

On Monday, 20th April 2020, something very weird happened. For the first time in history, US oil price nose dived into negative territory. Of all the unprecedented news coming from capital markets, bond markets, central banks, economic outlooks, due to the Corona virus, this one has to be the craziest (yet?)

It is hard for anyone to imagine a commodity price to fall to zero, let alone being traded at negative prices. It becomes even harder to wrap your heads around the fact that that commodity is oil. However, that is exactly what happened on 20th April 2020 when WTI (West Texas Intermediate) Crude futures expiring in May plunged 321%, to -$40.32 a barrel.

Negative oil price: What really happened?

Crude oil prices have corrected heavily on the back of the coronavirus pandemic. But yesterday’s was not like that, both on nature and scale. Such a drop happened because of multiple issues overlapping, which has been long coming.

Low Demand

The latest Oil Market Report by International Energy Agency estimate that demand in April 2020 to be 29 million barrels/day lower than a year ago. Down to a level last seen in 1995. This is because of the near complete shutdown of entire countries, transport sector, airlines, industries, etc.

High Supply

The Saudi-Russia Oil Price War leading to excessive supply by two of the biggest oil producers post mid-march has led to huge amounts of low-cost oil flooding the markets. This comes especially at a time when demand is already very low.

No storage and Futures expiry.

A futures contract is a financial derivative that oblige the contract holder to buy (or sell) the specific commodity by a future date (on contract expiry date). In the current scenario, WTI crude futures were supposed to expire on 21st April 2020. A peculiarity of WTI is that if you are holding futures on expiry date, you must take physical delivery of oil.

On a regular expiry day, this would have been a normal affair. Traders (who are not interested in actual physical delivery) would sell those contracts to players who would require physical oil. Since there was no demand for physical oil from such players, there were no buyers for these contracts. This led to the traders panicking and wanting to get rid of the contracts at cheap prices.

The situation was so bad that the prices not only reached so low and ultimately zero, the prices still fell into negative territory, meaning that the sellers were paying money to buyers to buy the contracts from them to take physical delivery of oil.

Besides this, most of the oil storing facilities in US were already nearing capacity (due to the already available cheap oil). This meant that even if one wanted to take physical delivery, storage was a problem.

Are we to benefit from this “Negative oil price”?

If one expects this fall in oil prices into negative to fully translate into a fall in petrol and diesel prices, you are in for a disappointment. This is primarily because:

  • India imports Brent Crude and not WTI Crude
    • WTI Crude is oil that has been extracted from oil fields in US and is a price benchmark for US customers. India has been importing crude form OPEC. For whom Brent Crude is the benchmark (which was still trading around $20 at the time).
  • This is temporary and has got more to do with trading than with oil
    • Oil being traded at negative prices is a temporary event and possibly a onetime event (unless the situation is similar at next expiry). Such prices are unlikely to continue and will definitely bounce back.
  • Oil prices likely to fall though
    • Even Brent Crude prices are likely to fall due to the underlying issues. Consumers can expect some fall in petrol prices over the weeks. However, the fall in prices need not transferred to the customers fully.

Final Thoughts

Given the severity of recent events, its natural for oil prices to be stressed. That being said, it is also unrealistic to expect such prices to sustain. Countries such as USA, Russia and Saudi Arabia must come together to ensure stability in markets. India (mostly through our government) have been enjoying the falling crude prices over the years. However, taxes still account for a huge amount in our fuel spending. Any reduction in taxes would definitely act as a catalyst to economic activities once the economy restarts besides the various stimuli.

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