What does a negative Crude Oil price mean?
Worldwide there is only a few topics of discussion currently coronavirus, gold and oil prices and after-effects of the lockdown. The most shocking of all was the oil prices after the WTI futures plunged to $0 and later in negative territory. Does this mean that next time when you go to the gas station to get your tank full the oil companies and instead of you paying them for the gas you will be paid for buying it? So let's find out how true is that claim in this blog and how the change in oil prices will impact business and economy.
Brent Crude Vs WTI crude
The petroleum names the crude oil based on the oil's geographical source.
Brent Crude, which is produced near the North Sea. Brent Crude is the benchmark for two-thirds of the world's oil contracts.
West Texas Intermediate(WTI Crude) is primarily is sourced from the Permian Basin. WTI crude is considered to be of superior quality and is much easier to refine.
Is Coronavirus alone to blame or there is more to it?
Recently oil prices have been a falling comet. There has been a sharp decline of more than 90% of the oil prices. It is important to understand what is the reason behind this fall. Coronavirus disturbing the basic economic rule of demand and supply which is almost applicable everywhere.
In the past, whenever the demand went down cartels would cut down supply accordingly to maintain a steady price but this time because of the ongoing Oil price war the oil-producing countries refused to back down. Also, each nation fears that if they increase the price they may lose their market share.
In March 2020, when OPEC member nations along with Russia failed to reach an agreement about cutting production to stabilize the price of oil. Saudi Arabia retaliated by increasing production sharply. This sudden increase in supply happened at a time when global oil demand was at a minimum as the world was dealing with the COVID-19 pandemic where there was a decline in the number of fights, passenger travel, shipping and trucking traffic. Also, the oil consumption in the industrial sector and manufacturing production was at the lowest.
There is a limited oil storage capacity worldwide and with countries refusing to curtail oil prices there was production exceeding the global storage capacity. With no place to store the new production, we saw the oil prices making their historic lows.
The hype around negative oil price
On April 20, for the first time, we saw crude oils price taking a massive hit. The memes on social media were quick to pick on oil prices after the WTI futures going as low as -$40/barrel. They made us wonder whether getting paid for buying oil was true but it is necessary to understand that the oil prices were still in the range of $15- $21 in cash or spot market and the May contract for Crude oil WTI futures went negative, as the contract was close to expiry. Further, the graph displayed below shows that the price of June 2020 contract is again positive.
To simplify this, the oil futures contract is a legal agreement wherein a buyer and seller would agree upon a predetermined price to honour the contract regardless of spot market price at the given date.
For example, assume that you enter into a contract where you think the oil prices will become $70-$100 in one-month and the oil futures contracts are priced at $50 per barrel. You also have the option to store the oil with the producer if the oil prices sink and sell the when they go up. The contract owner can also sell or transfer this contract to another person in the given time. By entering into this contract, in one month the producer is obligated to deliver a barrel of oil and is guaranteed to receive $50. Irrespective of whether the oil prices are $20 or$ 70 in the cash market one month from now.
In the current scenario, the prices have gone down and now you don't want to sell them at lower rates so you ask the producer to store it but as discussed above the inventories are already full. Now the problem with storage of oil is that you need specific government sanctions and safety regulations to store it and if the producer delivers the oil to you and you don't have the storage there are chances that you will be fined heavily by the government if caught storing it illegally. So now if you tell some other person to take the oil the delivery he would be facing the same restrictions to avoid this the owners of the contract paid the buyers to get rid of their oil stock.
So the oil prices didn't become negative even if you go to buy oil you will have to pay their spot prices which are in the range of $15 - $21.
Impact of falling oil prices
All oil producers are currently in the loss as they are not even able to recover their production cost given the low oil prices. Companies such as Whiting Petroleum and Diamond Offshore Drilling have filed for bankruptcy.
Oil importing countries can benefit from this situation as it would positively impact their balance of trade. On the other hand, aviation and paint companies using crude oil as raw materials can benefit from it but even they cannot reap the benefits as there is total shut down in total flights people and people are less likely to renovate their houses in midst of COVID-19.