For the first time in oil trading history, negative oil prices came into effect in April 2020 for West Texas Intermediate (CL) crude oil future contracts. It dropped by almost 300%, trading at around negative $37 per barrel. As time went on, the prices for CL oil continued to remain low, trading at just above $20 per barrel. Likewise, Brent Crude oil (EB) was also weaker, dropping down by 8.9% and at less than $26 per barrel – a third of which it cost at the beginning of the year.
In the oil trading market, Brent Crude (EB) and West Texas Intermediate (CL) are the benchmarks used to reference the prices for crude oil. EB oil is extracted from the North Sea, commonly used in the production of gasoline and diesel, and classified as a ‘light’ oil. CL oil, also known as WTI, is extracted in the United States, ideal for gasoline refining, and is categorised as very ‘sweet’.
The severe drop in oil prices came as a reaction to the ongoing coronavirus pandemic and global lockdowns. Because of this, offices had been forced to shut and factories had stopped production. The lack of travelling nationally with fewer drivers and public transport services, as well as a cease in air travel, saw the demand for oil deplete, almost grinding to a halt, and leaving fuel unused. As an industry based on the supply and demand of a physical commodity, it saw an unprecedented high volume of supply, overcome with a flurry of production which would be too expensive to stop, but with no demand for it. These major events resulted in the oil futures contracts falling below zero for the first time and negative oil prices.
Oil is traded on its future price, with future contracts working on the basis of an agreement between producers and consumers to lock in a purchase price for a transaction at a later date. In these volatile times, as May 2020 future contracts were due to expire, traders were keen to sell short to offload the surplus of oil, and in order to avoid taking the delivery and possibility of incurring storage costs on an asset that had no demand for it.
There was a fear that the storage space of this commodity would reach capacity. And rightly so, as there was in fact a shortage of storage for a short period of time, resulting in negative oil prices – where companies were paying other buyers and investors to take the oil away and exit the market, rather than accept delivery. Experts in business have said that at its lowest level, the demand bottomed out to down 30%, which has never been seen in the last 40 years of world oil trading.
Those who trade in oil futures, and had no capacity to store the oil, found themselves having to sell quickly – as once contracts expire, buyers must physically take possession of the oil. Traders were having to take a short position as the trend of a bearish market took place.
As forementioned, EB oil is mined in the North Sea, where there is plenty of tanker storage, while CL oil storage is reliant on the areas in the US, which are limited as well as landlocked. Although, EB oil did experience a dramatic fall in prices, it was CL oil that was hugely hit by the supply and demand shock, and prices that were sensitive to the impact of the coronavirus.
For future trading, if lockdowns were to continue to be put in place, and continuous restrictions on air travel, oil prices could go negative again, with experts warning that there are pessimistic prospects for oil companies and oil prices. There could be a resurgence of supply exceeding the demand, and the reduction of available storage space.
