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.
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