Why Did Oil Price Fall Below Zero? It’s More Than Just Oversupply
For the first time in history, the price of one of the oil benchmarks fell to below zero on Monday. But how did it come to this?
Firstly, when you hear the price of oil being quoted in the news, it doesn’t reflect the price of a barrel of oil sitting somewhere on the supermarket shelf waiting to be bought. More likely they are referring to the price of the futures contract. To those unfamiliar with the term, it is a “contract” in which you buy or sell a commodity at “a predetermined price at a specified time in the future”. The oil rarely passes through the hands of these oil traders—before the deadline arrives, they would have sold the “contract” or oil to those who actually use the oil, eg. refineries, at what they hope is a higher price and pocketing the profits.
So, the simplified recent chain of events that led to the West Texas Intermediate trading at negative on the Chicago Mercantile Exchange is this: the COVID-19 outbreak happened, causing trade, manufacturing and overall movement of people to come to a halt; as a result, no one is using the oil and traders were not able to offload their “future” stock; and the coup de grace took place on Monday because the May contract for the WTI expired on Tuesday, and traders were frantically trying to sell their contracts or they would have to take possession of physical oil. And no, you can’t buy a barrel or two to fill your bathtub. The WTI futures contract encompasses one thousand barrels of oil or about 160,000 litres, so unless you have a swimming pool in your backyard or a tiny moat around your house…
So, you can imagine how desperate the traders were to relinquish the contracts, because all that oil and nowhere to put it. So desperate they were that they willing to pay someone to take them. With the huge dip in demand but a smaller dip in production, storage facilities for oil are already filled to capacity and getting very expensive.
It has reached a point whereby floating storage is being used to store the excess oil—ie. ships. Traders are chartering oil tankers that can carry about 2 million barrels of oil and charter rates are between US$335,000 to US$350,000. Reuters reported that the number of oil tankers used as storage and anchored near coastlines climbed from ten in February to up to 40 in early April and could possibly reach 200 in the coming months if the situation doesn’t turn around.
China, on the other hand, which is emerging from the lockdown and slowly returning to normal, is taking advantage of the situation and has been busy buying up spot oil (off the supermarket shelf, in a manner of speaking) and futures at deeply discounted prices. But even China’s stockpiling and the agreement between Russia and Saudi Arabia to cut supply may not be enough to reduce the global oil glut, not until the world starts using oil again. Perhaps you’ll actually have time to dig that moat…