Matt McLoughlin

Negative oil prices – how is this possible?

Matt McLoughlin

Crude oil was trading at negative prices on the futures markets yesterday (20 April), reaching a low price of -$40.32 a barrel at one stage. This means buyers of future contracts were being paid to own barrels of oil. How is this possible and how has this happened?

The starting point is the fact that oil prices have slumped because of the impact of COVID-19 on the global economy. A massive drop in demand has resulted in a surplus of oil – with storage being overwhelmed – and therefore falls in prices. This slump has not been helped by the recent spat over production between Russia and Saudi Arabia.

So how has the falling oil price caused futures contracts to now trade on negative prices?

Crude oil is the world's most actively traded commodity, and the NYMEX Division light, sweet crude oil futures contract is the world's most liquid platform for crude oil trading. It is also the world's largest-volume futures contract trading of a physical commodity.

The key here is the physical settlement of the contract (instead of profit and loss cash settlement). If you buy futures and own them when they expire, you are going to own and get delivered barrels of oil (each contract trades in 1,000 barrels so you need a pretty big garden to store them in). 

Due to the future contract’s usually excellent liquidity and price transparency, it is used as a principal international pricing benchmark. The contract getting all the attention expires today (21 April) and people who are long the contract and who don’t want to take receipt of hundreds of thousands of barrels of oil, need to sell it and “roll” into the June West Texas Intermediate (WTI) crude futures contract (selling the May futures contract and buying the June futures contract). 

This means there are a great number of forced sellers who have left it late to roll into the June contract and with inventories at historically high levels, supply only recently being cut, demand at all-time lows and there not being any tankers available to store the physical oil, those who are long the May futures contract are having to sell it quickly.

This has been why the WTI May Crude Futures Contract has gone into negative territory for the first time ever. The futures contract was showing that the cost of a barrel of oil was as low as -$40.32 yesterday evening. 

While the WTI Crude May Future price was negative yesterday, the June Future price was at +$21.09. When the May contract expires at the close of business today, the crude oil price that is being quoted in the news as negative (technically it is right now) will be positive again. Although these are still huge moves by historical standards, the -298% drop in the May contract looks massive compared to the -15.74% loss in the June contract and the -8.26% in the July contract yesterday

The further out you go on the contracts, the higher the price is.  Just before the end of contract trading yesterday the May contract was-$36.22 a barrel (negative), while June was +$21.09 a barrel (positive), July was +$26.99 and August was +$29.08.  This suggests the market is seemingly pricing in some kind of normality for the next few months, albeit a new normal anyway as the December contract is not much higher than August at +$32.74. 

There is not much point looking too far out date wise on these contracts though, as the nearest futures contract is always the one that has the most liquidity and is the one most closely followed. Contracts further in the future are not tracked as closely and therefore cannot give great predictions, not that any of us can at the moment.

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Tuesday, April 21, 2020, 2:39 PM