Negative oil prices and what it means for the economy

5 min readApr 21, 2020

On 20th April 2020, the price of the WTI oil for May futures contract turned negative due to storage issues. The cost to have a barrel of U.S. crude delivered in May plummeted to negative $37.63. It was roughly $60 at the start of the year.

A lot of bouncers? Let’s understand this word by word.

What is WTI Oil?

The international benchmark for crude oil prices is Brent Crude which tells us that price of oil at the international level. Similarly, West Texas Intermediate (WTI) is the benchmark for oil prices in the U.S.A. The significance of a benchmark in the oil market is that benchmarks serve as a reference price for buyers and sellers of crude oil. Oil benchmarks are frequently quoted in the media as the price of oil. WTI is not the most commonly used benchmark globally, that honor goes to Brent, where two-thirds of oil contracts globally use Brent as a benchmark. Both, however, are considered high-quality oils and are therefore the two most important oil benchmarks in the world.

WTI is the main oil benchmark for North America as it is sourced from the United States, primarily from the Permian Basin. The oil comes mainly from Texas. It then travels through pipelines where it is refined in the Midwest and the Gulf of Mexico. The main delivery and price settlement point for WTI is in Cushing, Oklahoma.

What is a futures contract?

A futures contract is a legal agreement to buy or sell a particular commodity asset, or security at a predetermined price at a specified time in the future. Simple, right?

Now let’s understand this in the context of oil prices and how one thing led to another to reach negative oil prices.

Jhunjhunwala (JW)is a trader who makes his money buying commodities like oil, wheat, aluminum, coffee, etc. at low prices and selling them at high, pretty simple.

Let’s say in November 2019, JW took a decision that in May 2020, he will buy 100k barrels of WTI oil for $40 per barrel from a guy named Buffett in May 2020 because JW thinks that prices will go higher than 40 and he will make money. So, a contract is created between the two and hence, JW will have to buy at $40, even prices go down to $10 in the market or even $5 for that matter.

But then coronavirus happened and was declared a pandemic in March due to which quarter of the world went into lockdown. The demand for oil fell so much that prices kept going down and never went above $40 p/b at all. Rather prices kept going down sue to a) rapidly falling demand, and b) price war between Russia and other oil-producing nations.

The contract expires on 21st April 2020 which means today (when I am writing this) is the last day. The problem with the WTI contract is that the owner of the barrels (JW in this case) has to physically take barrels himself from the site on the date of expiry. The market of oil has a large number of traders who cannot take physical delivery and are forced to sell it to the physical traders before the contract expires.

The issue comes here.

Since the oil demand is pretty low already, those physical players already have so much inventory that they cannot take more barrels as storage space is not available. The non-physical traders were then literally forced to create bids in the market so that people volunteer and come forward and take oil off their shelves. The bid went so low that those who volunteered got a barrel + additional $37–39 per barrel to receive the full consignment.

This led to negative oil prices for the futures contracts for May, the June contracts were still trading at +$20 per barrel. Since there is no obligation of the physical delivery of the oil in Brent Crude contracts, hence its price didn’t turn negative, although it also fell below $20 per barrel, the first time in 18 years.

How does it affect you and me?

It doesn’t affect us much as at the oil pumps, you won’t be paid for filling your Maruti Suzuki Swift’s tank. Although a typical American family, for example, will save $150–$175 per month if the oil prices decrease.

“We’ll continue to see gasoline prices, diesel prices, and jet fuel prices drift lower into May but one shouldn’t conclude that we are gonna get fuel given away or that we are going to match this incredible, unprecedented drops we saw in the crude oil today”, said Tom Kloza, a veteran analyst with Oil Price Information Services.

We might not see any effect in India because we do not buy oil from the U.S.A, we buy a different variant, a weighted average of Dubai and Brent crude. This, as we call the Indian Basket, is trading at about $20 per barrel. But this is still very low, right? So why aren’t Indian consumers getting any benefit?

Because very few things fetch the Indian government a considerable amount of taxes, and oil is one of them. The current government carried over a significant fiscal deficit in 2014 and reduced it to 3.3% in 2019 because the Indian petrol/diesel prices didn’t change, although the global prices came down to about $45 per barrel from about a $100 during the previous government’s era.

And now since there is negligible economic activity and government is desperate for revenues to fight coronavirus, any amount in the government’s purse is welcomed with open arms. So, even if the prices go down to $5 per barrel, we are unlikely to see any price change in India.

What does it mean for the economic rebound?

To see how the traders and/or investors see the future, we can see June futures contracts which, in this case, also fell 18.43% to $20.43 per barrel. That tells us how people are thinking about the demand rebound and consumer demand for energy in the immediate future.

As much as 30 million barrels or 30% of a day’s supply is lying at storage units across the world in since past 2–3 months, which means that the recovery’s not gonna be seen anytime soon and there is a supply glut.

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Negative oil prices and what it means for the economy

Written by Lakshya Narula