Crude oil prices didn’t fall below zero, futures did – and here’s what it means
Crude oilfutures dropped below zero for the first time in history, showing that there is excess supply and low demand for crude oil as the world is in lockdown due to the Coronavirus pandemic.
- US crude oil prices, on the other hand, fell under $15 per barrel, its lowest in the last 21 years.
- If the lockdown continues for a longer period, the demand for crude oil won’t pick up – this could have a negative impact on WTI crude oil futures for June as well, which is currently trading at $21.40.
Crude oil futures dropped below zero for the first time in history, showing us just how much the demand has collapsed due to the Coronavirus pandemic. Essentially, many might be wondering if oil companies would pay you to buy oil from them. The reality is far from this.
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West Texas Intermediate crude oil futures contract for May plunged to negative $40.32 – a first in the history of crude oil. Note that this is the price for a futures contract, not crude oil itself.
Futures contracts are different from actually buying the commodity or company stocks. Let’s understand what futures contracts are.
AdvertisementWhat are futures contracts?
Futures contracts are agreements to buy or sell a particular commodity or an asset at a future date. When it comes to crude oil futures, contracts are allowed for up to nine years in the future.
Each futures contract comes with an expiry date – on this date, the seller has to physically deliver the commodity to the buyer or the holder of the contract.
Essentially, a futures contract is a promise to buy or sell the commodity at a future date. The amount to be paid will be decided based on the market prices on the date of expiry of the contract.
How do crude oil futures work?
Let’s understand this with an illustration.
Imagine a scenario in which you are the supplier of crude oil and I am the buyer. We enter into an agreement to execute the transaction at a future date, say May 19.
AdvertisementAccording to our agreement, you will have to deliver me crude oil by May 19. I will have to take the delivery and pay the market value of the contract as on May 19.
Each crude oil futures contract is for 1,000 barrels. If the value of the contract on May 19 is $20, I will have to pay you $20,000 and take the delivery of 1,000 barrels of crude oil.
There is no ‘space’ for crude as demand falls
Due to the ongoing Coronavirus pandemic and lockdown across the world, demand for crude oil has collapsed.
Buyers of WTI crude oil futures have to take delivery on April 21 in Cushing, Oklahoma. Due to the collapse in demand, there is little, if any, storage space available. As a result, buyers are rushing to sell their futures contracts to avoid taking delivery of crude oil.
Due to this, there is a massive mismatch between demand and supply of crude oil futures – there are only sellers and no buyers, resulting in WTI crude oil futures for May crashing to negative figures.
Does this mean crude oil is now free?
AdvertisementNo. Oil refining companies will have to still pay a price for crude oil. Currently, US crude oil prices are a shade under $15 per barrel. Brent crude futures are currently trading at $25.34.
How significant is crude oil futures falling below zero?
The massive fall in WTI crude oil futures shows that there is no more place to store oil in the US at the moment. With most of the US and many parts of the world under lockdown, refineries don’t have any capacity left to store crude oil.
Will this lead to a fall in petrol prices in India?
AdvertisementThe fall in WTI crude oil futures will not affect the fuel prices in India. India mostly imports Brent crude, which is comparatively stable at $25.34 per barrel.
However, a further decline in crude oil prices could help the Indian government reduce the current account deficit (difference between total value of imports and exports). This will improve the value of the rupee and keep inflation under control.
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