On the final full day of trading before the expiration of the May WTI futures contract, prices went below zero. Never in the history of oil trading have prices gone this low. It was truly an unprecedented moment that left even the most experienced traders shocked.
A negative price meant that anyone holding a long futures contract (i.e. they would have to receive a delivery of oil the next day), was willing to pay someone up to $37.63 a barrel to take that contract off their hands. The total fall in prices that day was $55.09, or 306% according to Dow Jones.
The drop in price was driven by fear that traders with long position would be unable to take delivery of the oil. In current market conditions there is a huge oversupply of oil, and space to store it is running out fast. This is a result of the collapse in demand due to the coronavirus, and its impact on transportation across the globe.
"Contango, also sometimes called forwardation, is a situation where the futures price of a commodity is higher than the spot price of the contract today."
At the same time as the May contract was trading negative, the June contract was priced at around $20. This meant that traders expecting a delivery a month later were willing to pay up $20, whilst the price for delivery in May was negative at -$37.63.
In other words buyers would receive $37.63 a barrel for May delivery, instead of paying out $20 a barrel for a June delivery.
As you look out to further dated contracts such as December, prices are as high as $32. This suggests there is optimism in the market that prices will rise, and the crisis will lessen towards the year end.
It is clear that supply is overwhelming storage capacity at present, and creating these unprecedented circumstances. The Oil inventory data is approaching all time record highs, and in a few months storage could reach maximum capacity. This can only be avoided by suppliers turning off their taps and/or the crisis improving quickly, and the demand for transportation fuel rises. Both scenarios currently seem unlikely.
The impact of the coronavirus is huge both in a medical and economic sense. However, at least with the economy things can recover quickly, recovery from illness is not so easy.
Oil will still be in the ground ready to be extracted, once things get back to normal. The unemployed can return to work, and businesses can reopen. This will all require the right support from Governments.
Economics is about supply and demand, and the oil market has learnt a lesson in a way it has never seen before. A major rise in energy production over the last decade has outpaced the world’s need for energy. The pandemic has highlighted this in a spectacular way. Solving the problems of the global economy once the crisis is over, however, will be much more complicated than just finding storage for crude oil.