A REPORT

ON

THE NEGATIVE PRICE OF CRUDE OIL IN APRIL 2020 - THE RARE

MISMATCH BETWEEN DEMAND AND SUPPLY

BY

AVANI MISHRA 2016AAPS0282U

Submitted in partial fulfilment of

COURSE ECON F211

UNDER THE GUIDANCE OF

DR. SARTAJ RASOOL RATHER

BITS Pilani, Dubai Campus

Dubai International Academic City (DAIC)
Dubai. U.A.E.

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INTRODUCTION

The COVID-19 pandemic is affecting almost all businesses across all industries. This is due
to lockdowns enforced in several parts of the world and a bleak economic outlook. With
drastic declines in consumer demand, the coronavirus pandemic has created a difficult new
world for the oil industry. On April 20, prices for futures contracts expiring on April 21, the
American benchmark for crude oil – West Texas Intermediate (WTI) – turned negative to
minus $37.63 a barrel. Spot prices also fell below zero, and panicky oil producers and traders
dumped a large volume of futures contracts. Prices for Brent, the benchmark for crude from
the North Sea, also crashed, although they stayed in positive territory. This means that for a
brief period of time, sellers were actually willing to pay buyers to take oil off their hands.

In order to understand the reason(s) for this rare mismatch in demand, supply, and storage
space available, we will look at how trading in the oil market works. WTI oil is traded as
futures contracts in the NYMEX (New York Mercantile Exchange) where traders buy and
sell monthly futures such as, for instance, May futures, June futures and so on. The sellers of
such futures will have to deliver a barrel of crude oil at the contracted price in the contracted
month just as buyers will have to take delivery at the contracted date.

As it is with all trading in commodities, there’s a huge speculative participation in oil futures
trading too. So speculators buy and sell contracts with no intention of taking delivery (in the
case of buyers) or offering delivery (in the case of sellers) of the physical oil, on the
contracted date. These speculators have to unwind their “positions” on the contract expiry
date. If they fail to do so, they will have to take physical delivery of the crude oil on the
contracted date.

What happened on April 20, 2020 was that speculators who had taken large bets on May
2020 futures began to unwind their “positions”. This was because the futures contracts are set
to expire today, Tuesday. Those not intending to take physical delivery have to square off
their contracts before the expiry date. So, speculators who did not want to take delivery in
May proceeded to unwind their “positions,” leading to the massive fall in prices.

Also with the pandemic bringing the economy to a standstill, there is so much unused oil
sloshing around that American energy companies have run out of room to store it. And if
there’s no place to put the oil, no one wants a crude contract that is about to come due.

By April 21, prices for the benchmark WTI crude were back in the black. But its brief stay in
sub-zero levels raised new questions that were beyond how long and how deep COVID-19
would cut demand. For producers, the negative prices had them worrying briefly about
paying buyers to buy their oil, but now they face longer term concerns, such as having to
curtail output; shut down producing wells and defer new well openings; put off exploration;
and file for bankruptcies or get acquired in a wave of consolidation.

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A Historical Review

Oil and natural gas prices have moved up dramatically during the early 21st century. From
1999 to 2008, the crude oil price spiked from under $25 per barrel to more than $160 per
barrel. Rapidly increasing demand in emerging economies, such as China and India, and
production cuts by the Organization of Petroleum Exporting Countries (OPEC) in the Middle
East drove the price of oil to record heights. At the same time, natural gas spot prices went
from under $3 per million BTU to over $12 per million BTU between 1999 and 2008.

Shortly after that, a deep global recession throttled demand for energy and sent oil and
gas prices into a precipitous free fall. By the end of 2008, the price of oil had bottomed out at
$53. The economic recovery that began the following year sent the price of oil back over
$100. It hovered between $100 and $125 until 2014, and then it experienced another steep
drop. Natural gas fell below $3 per million BTU in 2009, but it was up to $6 per million BTU
by early 2014. However, natural gas prices declined sharply during that year. Spurred by the
negative effect of high oil prices on their economies, countries such as the U.S. and Canada
increased their efforts to produce oil. United Sates of America and Canada countries were
able to boost their oil production sharply, which put further downward pressure on world
prices. Saudi Arabia's actions also contributed to the 2014 oil glut. Saudi Arabia kept its
production stable, deciding that low oil prices offered more of a long-term benefit than giving
up market share. Saudi Arabia produces oil very cheaply and holds the largest oil reserves in
the world. So, it can withstand low oil prices for a long time without any threat to its
economy. In contrast, extraction methods such as fracking are more expensive and not
profitable if oil prices fall too low. Saudi Arabia hoped that other countries, such as the U.S.
and Canada, would be forced to abandon their more costly production due to lower prices.

This slump of 2014 was the most recent fall in oil prices before 2020. In early 2020, because
Russia would not agree to cut oil production - Saudi Arabia lowered oil prices drastically.
The Saudi Arabia – Russia standoff along with the slump in demand caused by the
coronavirus caused oil prices to drop to a 17 year low.

The US crude for May delivery turning negative on April 20, 2020, however, is something
that has never happened since NYMEX oil futures began trading in 1983. It was easily the oil
market's worst day on record. It harder to see what this means for the future of oil because
this is an unprecedented event. The May U.S. WTI contract fell $55.90, or 306%, to settle at
a discount of $37.63 a barrel after touching an all-time low of -$40.32 a barrel. Brent(a crude
oil blend whose price serve as benchmark to worldwide oil markets) was down $2.51, or 9%,
to settle at $25.57 a barrel.

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May WTI futures prices went negative but June futures prices are still at $20.43 a barrel. The
gap between the two contracts is by far the biggest ever. This could be due to two reasons:

Firstly the traders expect demand to recover by June as lockdowns are lifted across the world
and economic activity resumes.

Secondly the traders also expect that storage space may be created as existing inventory is
drawn down. America is also talking of adding to their strategic storage by taking advantage
of the low prices. This could create demand for oil.

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The Present Perspectives On Consequences And Implications

The market sentiment to this occurrence is that negative oil prices were not a random
anomaly. In fact, it is a warning. If producers do not cut supply, prices will turn negative and
force them to do so. The collapse of crude oil prices and their falling straight into the negative
range was an indicator of how scarce the storage space for oil is getting. This steep sliding of
prices is the markets way of telling the producers to slow down. The people who were
holding the futures contacts of oil on April 20, 2020 would have had to take delivery of the
oil at the Cushing storage hub in Oklahoma if they did not get rid of them before trading
stopped. And because the oil supply is much more than the demand for it and they have
nowhere to store it, they had to get rid of the obligation to take that delivery, at any price,
even if they had to pay someone to take the oil delivery.

The oil supply numbers everywhere are discouraging. OPEC as well as non-OPEC producers
are not acting fast enough. Bloomberg mentions that “other benchmark crude grades, such as
North Sea Brent, don’t have the same physical delivery requirements as WTI, which may
give them some protection from falling into negative territory. But Intercontinental Exchange
Inc., a leading provider of online marketplaces and clearing services for global commodity
trading, is already preparing Brent crude contracts for negative trading. And some physical
crudes priced at big discounts to Brent are already very close to zero.” But at the same time,
the lack of storage space at Cushing that triggered WTI's sub-zero dive doesn't look likely to
improve by the time the June contract expires, although the realization that prices can
actually turn negative may help avoid a repeat in mid-May.

Now, in India storage tanks are almost full. Tankers of crude oil are starting to build up off
the coasts of America. Even well known storage areas like those in South Africa are
crowding up.

Several business studies think that due to this pile up the oil industry might take decades to
recover, not just years and that the virus is going to leave massive spare capacity all along the
supply chain. The reason for this is that it is uncertain as to what will be the new demand for
oil once the COVID-19 is a thing of the past. But it is certain that the demand for oil is going
to be lower than it was in 2019, and it could continue like this for many years. This will most
certainly create overcapacity throughout the whole supply chain, which will then weigh on
the prices. Royal Dutch Shell Plc’s CEO - Ben van Beurden, said that oil demand may never
recover fully.

A report by analysts from Citigroup suggested that fuel consumption levels will not be back
at the 2019 level even by 2022. They also predict that there will be a long term demand drop
of 5%. A loss like that will cause structural overcapacity, right through the oil supply chain.
There will be too many wells to get oil out of the ground, too many ships to move it, too
many refineries to process it. And all this means prices will not rise.

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Another thing to note is that during the path to recover, every time oil prices rise, producers
will rush to use their idled capacity, undermining the recovery. After the oil-price slump of
the mid-1980s, it took two decades for prices to return to their previous levels — longer if
you build in the effects of inflation. This time the wait could be even more prolonged.

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POLICY MEASURES TAKEN BY VARIOUS AUTHORITIES

The oil prices falling to break all low records in the past is a concern to all economies as such
incidents in the past have seen the industry reverse decade long booms and go down into deep
recessions that might also push dozens of companies into bankruptcy. The only government
that undertook public discussion till now is the USA. U. policymakers for decades have
focused their policies on ensuring the oil supply shocks that damaged the US economy in the
1970s would not return, and they created a national reserve to backstop the market and ensure
supplies were available to fill up the nation's fleet of automobiles and trucks. But with US
production hitting record levels late last year and storage tanks now brimming with fuel,
Washington has few tools at its disposal to lift oil prices to levels needed to sustain the
energy industry.

However, the ability of the government to fundamentally alter this situation is limited. The
real problem is that more that 20% of the world’s oil demand is wiped of, mainly due to
COVID-19 related lockdowns. President Donald Trump pushed Russia and Saudi Arabia to
end a market standoff and reduce shipments oil. But those cuts won't take effect until at least
May, hurting near-term prices for crude and leaving oil producers scrambling to find storage
for their production.

The Congress rejected an US Energy Department request for $3 billion to buy oil to top off
the nation's Strategic Petroleum Reserve, but the agency is now allowing companies to lease
space in the facilities for 30 million barrels of oil. But even that amount, as well as another 47
million barrels that could flow into federal storage in the coming weeks, will do little to stop
up the extra production that is adding more than 2 million barrels per day to private storage
tanks. There are also reports that say that the government is considering paying oil companies
to stop pumping more oil and classify the supplies still in ground as a part of the nation’s
strategic reserves. This, however, still will not help much and many companies might still
have to head towards bankruptcy in this sector.

The OPEC nations, Russia and a groups of other producers agreed to cut production by 9.7
million barrels per day starting in May, and producers in the U.S. and Canada are shutting
down wells in a retrenchment that's expected to remove millions of more barrels in the
coming months. Until that supply shrinks or there is a rebound in global demand — which is
estimated to have declined by 20 million to 30 million barrels per day — there is little chance
the industry will return to firm footing. Another concern is that a group of oil tankers that left
Saudi Arabia before the country agreed to cut production is currently heading toward the U.S.
That oil will further strain storage capacity unless another country buys them before they
reach the U.S.

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CONCLUSION

To conclude and give my views on the topic I will elaborate on two fronts: Geopolitical
Crisis and the Social Crisis.

First, I will discuss the Geopolitical Crisis:

The challenges and opportunities that the collapse in the oil market is pushing to the forefront
are perhaps just the first glimpse of Covid-19 induced geopolitical crises that government
leaders and policy makers will need to grapple with in the coming months and years. History
has shown, a big change in energy markets often precipitates a big change in geopolitics. An
example is when the world shifted from coal to oil, the middle east had a real life rags to
riches transformation. The strategic significance of multiple counties changed.

Right now, the governments should take the pressure which the massive drop in oil prices
have created and make a number of strategic choices. According to a report by the IMF, no
major oil producer in US can balance its budget at prices below $40 per barrel. Every country
in the Middle East except Qatar requires at least $60, Algeria - $157 and Iran a
whopping $390. The average Brent price of oil over the past month(mid-March to mid-April
2020) has been a just a little above $20 Therefore, for several oil producers, the plunge in oil
prices is devastating.

It is true that financial break-even prices are only one factor when gauging which oil
producers are the most vulnerable to deep economic dislocation and its accompanying social
and political turmoil. Contries with relatively more diversified economies such as the United
Arab Emirates, Mexico and Russia are obviously better off. Countries with fixed exchange
rates like Nigeria and Saudi Arabia are at a particular disadvantage, as they need to use their
precious foreign exchange reserves to prop up their currencies.

Even in this crisis, some countries have the capacity to cut expenditures, borrow, or manage
the inevitable hardships as subsidies are slashed, jobs are lost and capital spending is
curtailed. But many do not. And this will prove to be testing times for them.

Now, moving to the Social Crisis I had mentioned previously.

It is known that as countries across the world have gone into lockdown in response to Covid-
19, economies are in the fall. Almost every sector is taking a hit, stabbing jobs and value.
And almost every sector will be shaped, for years to come, by the speed, amount, and nature
of public assistance it receives. There is a finite amount of time, resources, and political will
available to get economies going again; not every sector will get what it wants or needs. In
short, the decisions legislators make in response to the coronavirus crisis will have an
enormous influence on what kind of economies emerge on the other side. And this is most
probably bad news. The governments love oil and it is now very likely theat the spending
happened there instead of maybe where it is more required. The financial stimulus packages

8
announced or planned by the governments might be used to prop up the oil market after the
tragedy of April 20, 2020. A report by InfluenceMap that tracks the lobbying activities
happening in the midst of the COVID-19 situation found that, across the globe, the oil and
gas sector has been the most active in lobbying for interventions seeking “direct and indirect
support, including bailouts, buyouts, regulatory rollbacks, exemption from measures designed
to protect the health of workers and the public, non-enforcement of environmental laws, and
criminalization of protest, among others.” In the US alone, the industry is seeking access to a
range of stimulus funds, relief from a variety of pollution regulations, and use of the strategic
petroleum reserve to bolster prices. This is not only taking away resources from other sectors
that might rightfully need it but also push us back in the fight against climate change if the
environmental regulations are relaxed to boost the industry.

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REFERENCES
1. www.bloomberg.com/opinion/articles/2020-04-12/oil-price-trump-s-saudi-russia-
cease-fire-won-t-last-long

2. https://www.bloomberg.com/news/articles/2020-04-23/kuwait-cutting-oil-output-
ahead-of-schedule-minister-says

3. https://budgetmodel.wharton.upenn.edu/issues/2018/12/14/the-price-of-oil-is-now-a-
key-driver-of-business-investment

4. https://www.wsj.com/articles/oil-prices-slump-as-crude-storage-shortage-intensifies-
11587382034

5. https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-
headlines/no-place-to-go-oil-storage-filling-up-amid-collapsing-demand-excess-
production-57865154

6. https://www.wsj.com/articles/q-a-how-oil-markets-work-and-why-prices-fell-below-
zero-11587582195?mod=searchresults&page=1&pos=2

7. http://www.uwyo.edu/economics/faculty-staff/faculty/charles-f-mason.html

8. https://www.eia.gov/petroleum/storagecapacity/storagecapacity.pdf

9. https://www.investopedia.com/articles/investing/102314/understanding-benchmark-
oils-brent-blend-wti-and-dubai.asp

10. https://www.cnbc.com/2020/04/09/oil-jumps-ahead-of-make-or-break-opec-
meeting.html

11. https://www.linkedin.com/feed/update/urn:li:activity:6658070853651095553/?comme
ntUrn=urn%3Ali%3Acomment%3A(activity%3A6658069479102263296%2C665807
0782578618368)

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