How negative oil prices revealed the dangers of the futures market

 

 Reuters

https://www.cnbc.com/2020/06/16/how-negative-oil-prices-revealed-the-dangers-of-futures-trading.html

• A historic drop occurred on April 20, when the price of West Texas Intermediate crude dropped by almost 300%, trading at around negative $37 per barrel. 
• The crash in demand that followed the spread of Covid-19, along with a price war between oil giants Saudi Arabia and Russia in early March spurred the move into negative prices. 
• As the delivery date for WTI grew near, investors began a massive sell-off to take the contract off their hands.
• The price of oil has steadily recovered, jumping nearly 90% in May and registering the best month on record for WTI.

A historic drop occurred on April 20,  when the price of West Texas Intermediate crude dropped by almost 300%, trading at around negative $37 per barrel. 

The price of oil has steadily recovered, jumping by nearly 90% in May and registered the best month on record for WTI. However, the petroleum industry is still reeling from the effects of the coronavirus pandemic. Major companies like Chevron, Exxon and ConocoPhillips have announced deep production cuts and Whiting Petroleum in April became the first major company in the industry to file for bankruptcy protection.

The crash in demand for oil that followed the pandemic played a major role in the move to negative prices. “At the trough, we probably saw demand in April bottom out down 30%. So we’ve never seen anything like this certainly in the last 40 years since world oil markets have developed,” said Severin Borenstein, a professor of business at the University of California, Berkeley.

To make matters worse, a price war erupted between oil giants Saudi Arabia and Russia in early March after OPEC and its allies failed to reach an agreement on deeper supply cuts. As supply remained steady while demand struck record-breaking lows, the industry quickly began running out of storage space to put their oil. This was devastating news for investors of WTI futures who are expected to take physical possession of the oil when the contract expires.

“WTI is special in a way because it’s so tightly connected to physical oil,” said Derrick Morgan, senior vice president of American Fuel & Petrochemical Manufacturers. 

As the delivery date for WTI grew near, investors began a massive sell-off to take the contract off their hands, prompting an unprecedented crash into the negative territory.

The historic drop quickly sent shock waves through the U.S. financial market. The Dow plunged by over 1,200 points over the following two days and brokerage firms took multimillion-dollar hits to cover customers’ losses. However, experts point out that although the event was unprecedented, there was no need to panic. “There were very few contracts. There was very little trading at those prices and the price very quickly rebounded into positive territory,” according to Borenstein.

Experts think the impact of the turbulent prices will likely be more severe for the U.S. shale industry, which is often in heavy debt due to its high production costs.