Why Crude Oil Prices Went Negative?

We have witnessed a rather unprecedented fall in the US crude oil (WTI) prices on April 20th, 2020. This is unprecedented because the US oil prices never traded less than $0 in history. In brief, the US WTI oil prices plunged because the producers ran out of storage to store the oil supplied by them. Due to Coronavirus scare, most of the global nations have put forth restrictions on the movement of people leading to reduced demand for oil. However, here we will try to see the things in a bit more detailed way to throw light on what has led to drastic fall in the crude oil prices.  

Who controls the oil prices?

Until the mid-20th century, the United States, the largest producer and consumer of oil controlled the global oil prices. However in 1960, a cartel known as Organization of the Petroleum Exporting Countries (OPEC) was formed in order to control the supply of the oil to influence the price of the oil. The members of the OPEC are 13* major oil-exporting nations of the world they are:

*Qatar terminated its membership on 1st January 2019. Thus at present there are only 13 member states. 

In 2016, 10 other non-OPEC members were included to form the OPEC+. The OPEC bloc is nominally led by Saudi Arabia, the group’s largest oil producer, while Russia is the biggest player among the non-OPEC countries. OPEC+ started controlling the global oil prices by adjusting the supply. For example, if OPEC+ members are unsatisfied with the oil prices, they cut the supply of oil. Conversely, in rare situations they increase the supply mostly to offset a low production by any of their member countries.

Zoom past to 2020: What happened now?

In March 2020, Saudi Arabia and Russia the top two oil exporting nations of the world failed miserably at reaching an understanding to cut the production of the oil to stabilize the price of the oil. As a result, Saudi Arabia started ramping up production at a time when the world was grappled by the Covid-19 pandemic. This over supply along with already sharp reduction of demand due to Covid-19, started taking the prices to the lower levels. Both Brent crude oil and WTI crude oil went down to lowest levels of the 21st century. The major difference between Brent Crude and West Texas Intermediate (WTI) is that while Brent crude is extracted from the North Sea, WTI is extracted from oil fields of the US located in Texas, Louisiana and North Dakota. However, it still doesn’t explain the fall in the oil prices to the negative territory, does it? Read on.

The Negative Zone Story:
On April 20, 2020 US crude oil futures (WTI) for May traded in the negative territory going as low as -$37 per barrel.  Does this mean that oil prices have gone negative as such? No. To understand this, we need to get into what the futures contracts are. A physical futures contract such as the NYMEX (New York Mercantile Exchange) WTI has a delivery point in Cushing, Oklahama in the US and delivery date which in this case is May. So when you purchase such a contract and hold the contract at the end of the trading window (known as futures expiry), you need to take physical delivery of the oil that you bought on the futures market. Since the expiry of May futures contract was on April 21st, 2020, trades or speculators who had bought the contract found themselves unable to resell the contract which means they will have to take the delivery of oil for which no storage was booked at the facility located at Cushing, OK, USA. For this reason, the speculators who hold the futures contracts started panicking and as a result WTI oil futures traded in the negative territory. Since India imports primarily from the OPEC countries, Brent crude oil is the benchmark for oil prices in India. Thus it is to be kept in mind that the fall in the US WTI crude oil futures prices does not have direct bearing on the oil prices in India.