The Rationale Behind Negative Oil Prices

What Really Happened On the Market

Probably, most of you have already heard about the rough times the crude market is currently going through. One of the benchmarks of oil prices, West Texas Intermediate (WTI), has been repeatedly going into negative territory in the last couple of days. The decline of the WTI front month futures contract, more than 300% on a daily basis on Monday, could be attributed to two main factors: on one hand, the huge oversupply state which market is currently in; and on the other, the drastically decreased demand for oil and oil products, caused by the damage the current pandemic has been doing on global economy.

The price for a barrel of the WTI sort with May delivery touched -$37.65 on Monday, which implied that sellers had to pay someone to get rid of their oil. This negative price affected the contracts for May delivery only. Futures maturing in June, July and so on also suffered sharp declines but still traded in positive territory.

The Forces Of Supply and Demand In the Context of the Oil Market Explained

Oil demand has really collapsed in recent weeks, as the health crisis around the globe has devastated pretty much all economic segments, thus virtually eliminating the use of fuel for shipments, transportation, etc. Without consumption, the world’s biggest producers are running out of room for storage of all the crude oil that companies even now continue pumping. As a result, we have got to the bizarre situation in which traders are willing to pay to get rid of their oil, rather than look for a place to store it.

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The collapse of the OPEC+ deal in March has resulted in the main producers badly flooding the market with millions of barrels of excess oil. On 12 April, the world’s top producers came back on the table and pulled off a deal to cut output by nearly 10%. The cut is clearly insufficient to dent the massive glut that keeps growing due to the pandemic-induced shutdown of the global economy, which has slashed oil demand by more than 30%. What we have seen on the market in the last couple of days clearly demonstrates this huge imbalance.

Why Is Gasoline Not Free Yet

With negative crude prices, you might be wondering why you are still paying for gasoline at the pump. Fuel prices have been falling substantially worldwide. It should be kept in mind, however, that oil is only the raw material which gasoline, diesel and other petroleum products are made from. For this reason, the price of the former accounts only for a fraction of these products. Companies like ExxonMobil and Royal Dutch Shell have a number of expenses in the process of refining the commodity and transporting the fuel to gas stations. In addition, taxes account for above 20% of the final price of what people pay at the pump.

Can Prices Stay Negative

Currently, we are clearly in uncharted territory, as oil markets have never seen negative prices before. Although no one can guarantee that this will not happen again, it is more likely that this crucial commodity will not trade in sub-zero values for a long period of time. Demand for crude is likely to remain subdued for some time, as business activity is not likely to stage a quick recovery. Low prices and the lack of room for storage, however, will also exert pressure on the big producers, like Saudia Arabia, USA and Russia, to drastically decrease production. This would in turn gradually lift prices to the more normal levels we are used to seeing.

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April 23, 2020