For the first time in history, oil prices have gone negative, meaning that theoretically, oil companies will pay to have their oil taken. This concept can be confusing to the average American, so this article will attempt to explain the recent whipsaws in the oil market.
On April 20, the price of Texas oil futures fell to a record low of -$37/barrel as a result of low demand and increased supply before rebounding the next day. For a few hours, it seemed as if oil companies would pay to have oil taken from them. Unfortunately, this doesn’t mean the average Joe could get paid to fill their swimming pool with oil.
Firstly, the West Texas price was in no way indicative of the oil market as a whole, which traded the same day at fairly normal prices of $20-$25/barrel. Secondly, the negative pricing wasn’t actually indicative of the price at which Texan oil was trading.
The reasons for this lie in how oil is traded, which is through futures contracts. Futures contracts bind buyers to a certain price at a certain date in the future, which helps suppliers manage storage and production well in advance. The -$37 price was exclusively for May contracts, which were set to be finalized a few days after the 20th due to the time necessary to transport oil through pipelines.
The 305% drop, though historic, was indicative of sellers’ desperation to alleviate their own storage problems rather than oil becoming less than worthless. It was also largely meaningless, since the cost of transportation and overall lack of storage has prevented most potential buyers from pulling the trigger on more oil.
The oversupply is triggered by a price war between Saudi Arabia and Russia as they compete for market share at the expense of American producers. For more detail on the underlying causes of the oil glut, see this article.
The obvious plan would appear to be simply stopping production rather than risking storage overflow. But this solution would be expensive, as shutting down wells, even temporarily, is more complicated and more costly than simply flipping a switch. Many producers choose to continue supplying oil at a loss rather than deal with the long-term costs of large production cuts.
As a result, production, though decreasing, still far outpaces demand, which has fallen by a third since the beginning of the pandemic. This leads to a dilemma, as producers are now hard-pressed to find a place to store millions of barrels of crude, gasoline, and other refined products waiting for delivery.
Since the brief dip into negative pricing, oil prices have stabilized somewhat after potential contracts with the Australian and American governments were announced. All things considered, however, it will be a bleak few months for the oil industry as prices remain low and the wells continue to flow.
