The more demand there is for something, and the more limited the supply, the higher the price will go. But what happens when demand for an item falls so much that you simply “can’t give it away”? This is what has happened to oil, in particular, oil in America. To understand what has happened in simple terms, and to work out how you can have a “negative price” for something, let’s look a bit further into the matter.
There are 2 main benchmarks for oil prices – (i) West Texas Intermediate (WTI) representing the US and (ii) Brent representing Europe and the rest of the world. In “normal” market conditions, their prices move together most of the time, however, as we know, the current markets are not normal.
WTI oil is landlocked (i.e. West Texas) and it is harder to move to where demand is found, unlike Brent oil which can be shipped. Hence WTI storage can be a factor, as it is now.
With the global demand for oil quite low and the market oversupplied, US producers have been selling WTI at negative prices to take into account the scarcity and high price of storage. In other words, the supply of storage is now so restricted the price of storing it has shot up. Back to our first point, demand for storage (rather than for the oil itself) has increased and supply/availability of storage has reduced as there is so much unwanted oil sloshing around in tanks.
At the time of writing (21st April) the May futures contract for WTI expires today so there is a rush to sell, given delivery is on 1 May but prices that were trading at $20 five days ago have fallen -$40 (yes you read that correctly) last night, before settling at $1.50 currently. The June contract was $28 five days’ ago and is currently $21, but could easily turn negative going into expiry (19 May) if storage issues prevail and there is no increase in demand.
So what is a “futures contract” and how does it work? Well, it’s basically an agreement to buy something at a date in the future, in this case; oil, at a price set now. The premise is that you agree to a price now in the hope that you’ll be able to sell it on at a profit by the time it’s delivered to you. So if a supplier agrees to sell oil at $20 dollars a barrel with delivery set for 1st May, the buyer can only avoid taking delivery of that oil if there is some means of moving it on, the aim being to sell it at a higher price – however right now, not only does no-one want to buy it at anywhere near $20 a barrel, there is also a shortage of storage to hold onto it until the market gets moving again.
If demand starts to increase, the oil supplies start to move and the storage facilities are freed up, then the price will recover but essentially at the moment, it’s a bit like having to pay for babysitting the oil that no-one wants.
We hope that you are all keeping well and safe and if you’ve got any questions that you’d like us to address in a future item, do please get in touch.
Angela, Jon and all the Acumen Team