BUSINESS
21/04/2020 8:15 AM IST

Oil Prices: Why Did They Fall Below $0 And Why Does It Matter?

In Texas, traders were being paid to buy barrels of crude amid coronavirus-fuelled economic fears.

REUTERS

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US crude oil bounced back into positive territory on Tuesday, after a historic plunge below zero that shocked investors and pushed down stock prices and Asian currencies.

The price of a barrel of West Texas Intermediate (WTI) crude oil for May delivery ended on minus - yes, minus - $37.63. On Friday, the same product was valued at $18.27. 

It led to the bizarre situation of oil producers paying buyers to take the commodity off their hands as they feared they had nowhere to put it.

Coronavirus is largely to blame

The coronavirus pandemic has meant the demand for oil has collapsed. This is the result of the virus’s spread to all corners of the world, lockdowns and other knock-on effects.

Put simply, factories closing and people scaling back on using their car has meant demand for the fossil fuel that literally fuels economic activity has diminished. And there were updates on Monday underlining how the virus is knocking confidence.

Germany is in severe recession and recovery is unlikely to be quick as coronavirus-related restrictions could stay in place for an extended period, its central bank said. Japanese exports declined the most in nearly four years in March as US-bound shipments, including cars, fell at their fastest rate since 2011.

But there’s also been a price war

Another major factor has been Saudi Arabia ramping up oil production after a falling out with Russia.

Although Saudi Arabia and the rest of the oil producing cartel Opec has now committed to slashing production again, these cuts have yet to make an impact on a market flooded by oil.

Too much supply, not enough demand.

It has meant that many of the world’s oil storage sites are full. The main US storage hub in Cushing, Oklahoma, is expected to fill up in a matter of weeks. With facilities unable to take any more, buyers are nearly impossible to find. 

 

The price drop may be a quirk 

Oil prices have been falling for weeks. But much of the plunge was chalked up to technical reasons.

Traders usually play a game of pass the parcel with contracts for barrels of oil. They will buy the right to collect 1,000 barrels at a specific date – but sell it on later, preferably for a higher price – before they have to pick up the oil.

Whoever owns the contract when it expires is obliged to take delivery of the barrel.

Normally traders have no problem selling their contracts to a refinery, or other business that wants oil, before the deadline.

But the deadline for May contracts is due to expire on Tuesday and against the backdrop of economic gloom.

It left traders desperately scrambling to get rid of their barrels so they were not left to pick up oil which they do not have the ability to collect and store.

As a result, traders were actually willing to pay a lot of money to anyone willing to take the oil off their hands.

So is oil ... free?

Producers without storage facilities will pay you to take the oil off their hands, and traders were actually being paid more than 40 dollars to buy a barrel of oil on Monday.

Anyone who was willing to collect oil on-site in Texas was able to pick up perhaps the deal of the century early on Monday evening. 

So for them, yes. They even made a profit.

How will it affect consumers?

The news made the normally obscure pastime of following oil prices explode as #OilPrice became the top trending topic on Twitter on Monday evening.

Gasbuddy.com and Oilprice.com, websites set up to track the price of oil and fuel, crashed under the strain of traffic flowing to their servers.

However, the collapse is unlikely to lead directly to significant discounts for drivers at the pumps. The price of Brent crude to be delivered in June was only down 10% at 25.63 dollars per barrel.

Big importing nations such as China, India and Germany could get some much needed relief from falling energy bills. And generally benefit from lower oil prices thanks to the decline in petrol prices at the pump.

But any reduction in prices will likely be eclipsed by the damaging impact to the economy caused by the coronavirus-led slowdown. This was highlighted by another fall on Wall Street (down almost 2.5%) as oil prices turned negative for the first time, underscoring the chaos the virus has unleashed.