Oil Prices Crash To Below Zero For The First Time In History

by Mehdi BAH

Oil Prices on the New York Stock Exchange has dropped to its lowest level in history.

The consequences of the corona crisis are becoming more and more noticeable on the crude oil market – especially for US crude oil. The price of a contract that provides for physical oil delivery in May was the first since the start of futures trading in 1983 in the negative range per barrel (159 liters). Then the price recovered slightly and passed the five dollar mark again.

Special phenomenon On the one hand, this shows how strongly supply and demand currently differ in the oil market. On the other hand, it is a very special phenomenon, due to the May futures contract on US oil expiring on Tuesday.

Due to a toxic mixture of a sharply falling demand and an excessively high supply, the storage capacities in many countries threaten to be exceeded. In any case, oil investors want to avoid finding a lack of storage space.

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In the United States, in particular, oil storage facilities are at risk of bursting at the seams. Since the end of February, inventories in the important delivery location of Cushing have increased by almost 50 percent. As a result, the purchase prices paid to continue to fall in the oil-rich region of Texas. In the meantime, there is even fear that negative prices will soon fall due for the purchase of crude oil if storage capacities shrink even further.

Slump in demand

The following futures contract on American light oil (WTI) cost significantly more on Monday evening than the May contract. A barrel (159 liters) of Texas Light Oil (WTI) for delivery in June was quoted at $ 22.30 in the evening. The North Sea variety Brent costs $ 26.50 a barrel. However, both prices were clearly in red.

Analysts also justified the slump with the sharp drop in oil demand as a result of the corona crisis and with doubts about the reaction of large oil producers to the crisis. As a result of the global oil spill, there is also a risk of scarce storage capacity.

The Strait of Hormuz is important for global oil supplies However, the drop in the price of the WTI May contract also underpins the basic situation on the oil market. This is characterized by a much too high supply with a strongly falling demand. The corona crisis is causing a global economic downturn, which is causing declining oil, petrol and diesel demand.

Large oil producers such as Russia and Saudi Arabia have recently announced significant cuts in production. However, experts doubt whether the reductions are sufficient to reconcile supply and demand.

So something has never happened before: The price of a barrel (159 liters) of oil the US WTI fell on Monday evening in trading in New York below zero – the first time had to pay seller that someone them the raw materials decreased. There is a brief technical effect behind this. But at the same time, the development highlights a fundamental problem in the oil market.

The trigger is, of course, the corona pandemic. Due to restrictions imposed by governments around the world, crude oil demand has collapsed, and estimates suggest that 20 to 30 percent less oil will be used.

Initially, however, the oil-producing countries were unable to agree on restricting production, on the contrary: in mid-March, they triggered another price war. At that time, the WTI price dropped to around $ 20. At the turn of the year, it was still over $ 60.

A week ago, Opec, Russia, Mexico, and the United States agreed to cut funding rates. But this was far too low, the overall production was only reduced by ten percent. Now the market issues the receipt. “With this last step, investors on the supply side have sent the clear message that if they want to reverse the situation on this market, they will have to step up their efforts considerably,” said Ipek Ozkardeskaya, an analyst at Swissquote Bank.

Oil Prices and Production greater than demand

The biggest problem at the moment is that the production has been far greater than the demand for several weeks now. The surpluses must be stored, but the stores are now threatening to fill up.

“The United States has the biggest storage problems,” said Jasper Lawler, head of market analysis at the London Capital Group. “The demand is so far behind the supply that the stores could already be 70 to 80 percent full.” Therefore, it is primarily the US variety WTI whose price is falling. The North Sea variety Brent, on the other hand, costs just under $ 27 per barrel on Monday evening.

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However, to understand the crash from Monday, a look at the overall market is also necessary. Because the price, which now fell below zero, is the price for a contract with the delivery of the oil in May. However, trading in it expires on Tuesday. This forward transaction must now be urgently sold by anyone who only speculated on the price but does not want to buy any oil at all.

However, if these speculators cannot sell the contract, they will receive the oil in May – even if they do not know where to put it. But apparently, they won’t get rid of the contract because nobody needs oil. Therefore, they have to go lower and lower with the price, hence the unprecedented crash. And in the worst case, they even have to pay for someone to take the oil from them.

At the same time, however, a June contract still costs over $ 22. Here investors still have hope that the price will recover by then. As soon as trading in the May contract has ended, the June contract will be the price everyone is referring to – and then the price can quickly be significantly higher again.

Price turbulence is likely to continue for some time

So that the same drama does not threaten at the end of May, oil production must be significantly reduced by then. After all, this happens more or less automatically in the USA. Because many oil producers are no longer able to cover their costs and go bankrupt. In doing so, you also stop funding.

But this process takes some time. The total number of drilling sites in the United States has already decreased. But, likely, it will still take a month or two before the number of drilling rigs has reached the level of earlier oil price lows, believes Naeem Aslam from the broker Avatrade. And it is not even certain whether that is enough to compensate for the slump in demand. The price turbulence should, therefore, continue for some time.

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