Negative oil prices explained

Anyone watching their twitter feed last night, or the evening news, could be forgiven for thinking that the world – already in shutdown due to the Coronavirus – was going a little crazy: the price of a barrel of oil went below zero – effectively meaning that, if you had the space, you would be paid to take it!

But, as with many things, there was more to it than first meets the eye. Here, we give you a layman’s guide to what happened – and why it will only be a temporary phenomenon.

Layman’s guide to negative oil prices

The crude oil markets are currently awash with crude oil because demand has pretty much fallen off a cliff as we are all staying home, but supply is still strong.

This demand/supply imbalance had already seen the price of a barrel of oil fall from around $60 per barrel at the start of the year to around $20 on Friday.

But the sharp fall into negative territory last night was not because the situation had got even worse. It was because crude oil is usually traded in contracts – and one is due to expire today.

Let me explain…

Most oil is traded in ‘paper’ markets rather than in physical markets. Traders buy oil futures – agreeing to take a certain number of barrels on a certain date, at a certain location. But they usually never actually receive these barrels (storing them can be a challenge!). Instead they roll the contract over onto a new one.

21 April (today) is the last day for holders of the ‘May WTI futures (paper) contract’ to sell this contract and so ensure that they do not have to ‘receive’ the physical oil during the month of May in a place called Cushing, Oklahoma (where oil is stored).

Cushing will have no storage room in May (it will be full), so holders of the May contract were basically willing to pay to get out of their contracts.

Will the oil price stay this low?

The short answer is: No. Tomorrow, the WTI oil price will reflect the June contract (currently at around $21 per barrel). But the demand supply imbalance is unlikely to be resolved by this time next month, so we could see the same thing happening again.

Clearly, oil fundamentals are pretty terrible. But yesterday’s (and today’s) price action is best understood as a quirk or peculiarity of futures trading – one that has been made much more extreme by the current situation.

What’s the best way to make money out of oil?

This article is provided for information only. The views of the author and any people quoted are their own and do not constitute financial advice. The content is not intended to be a personal recommendation to buy or sell any fund or trust, or to adopt a particular investment strategy. However, the knowledge that professional analysts have analysed a fund or trust in depth before assigning them a rating can be a valuable additional filter for anyone looking to make their own decisions. Past performance is not a reliable guide to future returns. Market and exchange-rate movements may cause the value of investments to go down as well as up. Yields will fluctuate and so income from investments is variable and not guaranteed. You may not get back the amount originally invested. Tax treatment depends of your individual circumstances and may be subject to change in the future. If you are unsure about the suitability of any investment you should seek professional advice. Whilst FundCalibre provides product information, guidance and fund research we cannot know which of these products or funds, if any, are suitable for your particular circumstances and must leave that judgement to you. Before you make any investment decision, make sure you’re comfortable and fully understand the risks. Further information can be found on Elite Rated funds by simply clicking on the name highlighted in the article.