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Black Monday: The day oil became cheaper than nothing


Pinidu Chandrasekera

By

April 30th, 2020


Negative prices? What happened to the oil market? Pinidu Chandrasekera is back to update you on the events that led to what is being dubbed, “Black Monday”.


THEY say that there is no such thing as a free lunch, but given that its price dropped to a cool –$US37.63 last Monday, it appears you can get free oil. [1]

A couple of weeks ago, I penned a column explaining the ramifications of a global oil war between the Russians and Saudis which sent the price of the so-called ‘black gold’ plummeting to historic lows. Given the impact of COVID-19 permeating the globe, I had to abuse a fairly expansive list of adjectives to convey how significant those events in March following the meeting of OPEC+ actually were.

If that was verbal diarrhea, well, I may as well start paying the water bills on the dunny because I’m going to be there for a little while yet.

The Deal

On the second weekend of March, following extensive negotiations involving the world’s top oil producers, OPEC (Organisation of the Petroleum Exporting Countries) and the G20, a deal was brokered to cut global production by 9.7 million barrels per day—a significant feat given that this represented approximately 10% of total daily global output. [2]

Even more remarkable (and a sign of the times we are living in) was that the deal was spearheaded by President Donald Trump, Russian President Vladimir Putin and King Salman of Saudi Arabia, a motley crew of world leaders who would liven up any zoom call.

Despite being seen at the time as crucial for the stabilisation of the global oil market, with Trump celebrating via Twitter “this very big business [was] back on track”, the deal only equated to around half of the global demand lost each day due to COVID-19 restrictions. The volume of manufacturing and transport activity suspended throughout the world dwarfed any production cuts major producers were willing to entertain. And when last Monday rolled around the verdict was clear, it was nowhere near enough…

Black Monday

Already dubbed by some as ‘Black Monday’, Monday the 20th of April was the day when the US benchmark price for crude (oil in its natural, unrefined state) dropped below zero for the first time.

Oil ‘contracts’ are delivered in months, and while the headline may proclaim boldly “Oil Prices Drop Below Zero”, what actually happened was that the May futures contract for West Texas Intermediate (benchmark for the price of US crude) was trading at below $0.00. Part of the panic can be attributed to the fact that the deadline for trading on the May contracts expired the next day (Tuesday 21 April), and anyone who had bought oil was expected to take delivery.

Meanwhile, the WTI futures contract for June (meaning delivery due in June) remained in the $20’s, still astonishingly low for US oil companies who require a price of $US50.00 per barrel just to break even.

Oil is not just traded between producers and consumers, there are a myriad of hedge funds, investment banks and other financial intermediaries—known as speculators—who occupy the global oil market. Much like everyday retail investors trade shares seeking dividend income and capital gains, these speculators trade WTI futures contracts as part of their investment strategy, hoping for a rebound in prices before the contract expires and they are expected to take delivery. This is why there was such panic and disarray the day before trading for May contracts expired, as institutional investors, hedge funds and speculators with oil contracts searched desperately for customers to take the stock off their hands.

Logistics of Oil

While it would undoubtedly cause a great deal of amusement, don’t expect to see huge oil tankers rumbling down Wall St to deliver barrels to men in pinstripe suits anytime soon.

‘Delivery’ for oil contracts actually takes place at a storage hub in Cushing, Oklahoma, and as hedge funds unable to take delivery (naturally) sold en masse, the price not only dropped to zero—it kept dropping as the demand for viable customers meant that sellers were effectively paying their buyers to take the product. [3]

And no, please don’t entertain any fancy ideas of storing barrels of oil in your garage because that won’t quite work either. Oil contracts consist of thousands upon thousands of barrels of oil being exchanged in any one trade, and each ‘barrel’ holds 159L of black gold—sorry.

Some economic theory

As a student of economics, you can imagine my delight (isolation is clearly getting to me) when I woke up on Tuesday (21/4) morning to a Bloomberg Businessweek headline which proclaimed: The Oil Price Crash in One Word: ‘Inelasticity’. [4]

The production of oil is incredibly inelastic (unresponsive to changes in price in the short to medium term) and production wells are incredibly difficult (and expensive) to shut down, so the pre-existing strategy of oil companies was to invest in storage facilities. If the price dropped, it would be cheaper and more viable to put any excess into storage rather than cut off or reduce supply. However, this situation is unprecedented in that not only has global demand dropped, it has essentially evaporated as a consequence of the COVID-19 shutdown.

Getting rid of excess oil isn’t as simple as dumping an excess supply of strawberries, it has severe ramifications both financially and environmentally. With storage facilities around the world reaching capacity and the economic slowdown from the coronavirus showing no signs of letting up, one thing is abundantly clear: Texas, we have a problem.

[1] Financial Review (2020) ‘Oil prices fall below zero again’, 21 April.  ‘https://www.afr.com/markets/commodities/oil-market-in-turmoil-as-price-falls-below-zero-20200421-p54lz3 (Accessed 27.04.20)

[2] Financial Review (2020) ‘Oil price war ends with historic OPEC-plus deal to cut output’, 13 April.  https://www.afr.com/companies/energy/oil-price-war-ends-with-historic-opec-plus-deal-to-cut-output-20200413-p54j8o (Accessed 27.04.20)

[3] New York Times (2020) ‘What Negative Oil Prices Mean and How the Impact Could Last’, 22 April. Available at: https://www.nytimes.com/article/negative-oil-prices-facts-history.html?campaign_id=104&emc=edit_win_20200426&instance_id=17952&nl=with-interest&regi_id=79769534&segment_id=26002&te=1&user_id=18182f34dcdb2b9fae5b09517b195742 (Accessed 27.04.20)

[4] Bloomberg Businessweek (2020) ‘The Oil Price Crash in One Word: ‘Inelasticity’, 21 April.  https://www.bloomberg.com/news/articles/2020-04-20/the-oil-price-crash-in-one-word-inelasticity (Accessed 27.04.20)

The views expressed within this article are those of the author and do not represent the views of the ESSA Committee or the Society's sponsors. Use of any content from this article should clearly attribute the work to the author and not to ESSA or its sponsors.

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