It was shocking and unexpected. The prices of oil hit negative territory for the first time in the history of oil trading. You might be wondering how that is even possible. However, it is true and the real question is; what do negative crude oil prices indicate or mean?
This is what I intend to share with you in this article. To provide you an explanation of what negative crude oil prices mean to you.
It is an interesting topic and you should be keen on it. This is especially if you are interested in crude oil trading or earning money from commodity trading in general.
Every commodity is affected by the forces of demand and supply. It is not different for crude oil.
The world needs and uses oil for various reasons. What would happen if there was no demand for oil or if the demand is destroyed by unexpected factors like it happened in 2020?
What do Negative Crude Oil Prices Indicate or Mean?
Negative crude oil indicates that there is no demand for crude oil. It happens when the price of an oil futures contract falls below zero.
In crude oil trading market, the future price is often higher than the spot price. This means that the price of crude oil for delivery in the future is higher than the price of oil being delivered today.
So when you find negative crude oil prices, it means that the price of crude oil delivery in the future is below zero.
It indicates that you are actually paying the person who owns the oil not to deliver the oil when the futures contract becomes due. You do not need the oil.
Negative Crude Oil Prices Explained
In this section, I will try and explain what negative crude oil prices are or rather what makes such a situation arise.
West Texas Intermediate (WTI) crude oil prices went negative for the first time ever. It was trading between $0 and -$40 per barrel.
You might ask, how can oil be traded in the negative?
Oil is traded using a tool called a futures contract. This is basically an agreement where you agree to exchange a certain amount of oil, at a set price but on a future date.
Everything is going well and there is need for oil in the world. At this rate, your oil futures contract will be honoured as expected and as agreed.
Then a global crisis happens.
Global Economic Crisis
This leads to a chain of reactions across the world. Countries institute lock down measures, closing borders and air travelling is stopped.
With most of global movement and logistics halted, demand for oil plummets. No one needs the oil any longer.
This is understandable because oil is the main source of energy for industries and it is used in fueling the global trade.
When there is little trade or limited movement, then the demand for oil would generally go down.
if you are holding an oil futures contract, you are at this point desperately looking for a way out of it. You do not need the oil anymore and do not want the oil delivered to you on the agreed upon date.
This could be for various reasons but at the moment, the main reasons are that there is no demand for oil, and it is possible you do not have space to store the physical oil once delivered.
This was the case with the oil futures contract for May, 2020. One needed to get out of that contract by April, 2020 so that you don’t have to deal with an actual barrel full of oil in May.
This is how negative crude oil prices happened. On April 20, 2020, the front-month May 2020 WTI crude oil futures contract dropped 306% or $55.90 for the session to settle at -$37.63 per barrel on the New York Mercantile Exchange.
Related: Why Crude Oil Crashed to Negative
Why hasn’t negative oil prices happened before?
Crude oil prices going into the negative territory was a first one for the oil industry.
Veterans and also beginners in the oil trading business had not witnessed this before. And why is that?
You need to realize that for several decades now, the world has not had a situation like the one presented by covid-19 crisis.
In most of the times, there are always people out there in the market with logistical and physical capabilities to buy extra oil and store until they can sell it for a profit.
However, with global demand for oil destroyed and plummeting, there was so much oil in the world and very little storage for it.
This meant that if you had an existing futures contract, you would have challenges if you received the actual oil with no storage capacity for it.
It was therefore a better idea for you to get out of that oil futures contract. This means that you paid for the oil not to be delivered to you.
Prices for WTI crude at every other point of the futures curve are still in positive territory.
This suggests that most of the disruption is focused on the very near term.
However, if producers keep pumping oil out of the ground, we could see more contracts go negative at some point in the future. Travel restrictions would add into this situation.
In conclusion, crude oil trading is driven by various factors that determine the market prices.
Some of those factors include the demand and supply of oil in the market. You could also have other external factors like geopolitics and now global economic shutdown due to a pandemic.
Negative crude oil prices indicate that there is no demand for oil in the market. It also means that there is no storage capacity for future oil deliveries.
If you are interested in oil trading, you should ensure you learn and understand how the oil futures market work. This would help you to anticipate various market scenarios and create strategies to deal with it.