22 April 2020

The oil price on the American markets turned negative: what should we expect next?

Radu Muşetescu

The announcement that the West Texas Intermediate oil to be delivered in May, a contract carried on the New York Mercantile Exchange, got, on April 20th 2020, to -40, 32 dollars per barrel (according to Financial Times) surprised everyone. Indeed, it was unexpected to see a “negative” price on TV, which meant that the seller must pay the buyer to take its goods. Monday will be remembered, by all standards, as a special day in the global economy history. However, it is perfectly logic given the current context of the oil market. The political economy “goes well”. Although the June quotation is somewhere around $20, if the global context does not change in the following period, the contract for the June delivery will also turn negative. This means that all oil wells will stop worldwide in 5-6 weeks, because no one works on loses. And after 4-5 months, a major energy crisis will start, because the industry’s engine will not have all spark plugs working when starting.

Image source: Hepta

No seller goes on the market to sell a product for a “negative” price: concretely, no seller offers money to a buyer to take its product. Indeed, one better stays at home, throws the product and keeps its money. It is not the same if buying the product comes with some additional obligations: if one sells you a broken plane, whose maintenance costs a lot and also its parking on any airport has a price, then, indeed, one could be asked, as a buyer, for money to get rid of that product. This is also what happened with the oil carried on Monday, April 20th 2020, on the American mature market.

From the very beginning, we must bear in mind that this negative quotation is not related to an “uncovered” spot price, but to a “mature” future price. Concretely, an accepted current price for a future delivery, respectively at the beginning of May 2020. This is important because the mature markets, also called “futures” in the financial jargon, are special prices. This is where are making transactions not only sellers and buyers on the real market of that product, respectively the oil producers, oil refineries or other industrial entities, but also financial investors (some call them “speculators”). The first have stocking and transport facilities of the product and are also using the “futures” markets, especially for the price risk management. Well, the financial investors are the ones to enter these markets to seek financial profits, without being involved also on the physical markets of those products. These investors are essential for the successful operation of financial markets, respectively for their liquidity assurance. And these speculators, once the last transaction day approaches (Tuesday, April 21th), have panicked trying to close their positions and not get an oil tanker at their desks. And the others “caught them” pretty well in terms of money.   

Due to the massive decrease of the oil demand, associated with the passengers and goods transport decrease (it is estimated, for example, a gas demand decrease in Europe for over 80%), but also a gentle winter, the already extracted oil and ready to “be delivered”  on the international market seeks an outlet. Throwing it on the sea, as Saddam Hussein did in 1971, is not an option, due to the massive penalties associated with environment protection. Therefore, this oil will, most likely (lacking of an industrial processing demand), seek a better stocking space and a better circumstance. So, oil refineries should buy now as much oil as possible to cover their necessities for the following period. Depositaries should do the same as the sellers will cover their “cost of carry” through the “negative prices” and the selling oil price will be a bonus. Shipowners should all fill their oil tankers and let them travel the world and then sell them at a good price, anywhere in the world. Or, hopefully not, but one can also abandon some older ships (belonging to shell companies) in ports or littorals of the Third World after previously getting the “negative” price paid by the seller.

President Donald Trump just announced that the United States of America will get somewhere around 75 million oil barrels to fill the country’s Oil Strategic Reserve, with underground reserves of 800 million barrels, located in Louisiana and Texas. Given the prices, they will most likely have a $2 billion net income.

But these short term reactions may hide what’s next. Of course we will not see refuelling stations paying the consumers to fill their cars with gas or diesel oil. On the contrary. If on short term these prices free fall will slightly reduce the fuels prices, on medium term – a few months –prices will grow. And there is one obvious reason for that: the bankruptcy of most of the oil and energy industry.

The massive decrease of oil prices will also bankrupt most of the oil industry operators. According to CNN estimations, quoting an energy consultancy company, Rystad Energy, such a circumstance will lead, in the US, to the bankruptcy of hundreds of companies in the field, and a decrease of this price, for June and the months to come, to $10 will bankrupt more than 1100 companies. This means that the energy industry will focus on bigger and more effective producers, which make them increase prices. The ones to survive this industry shock will then lead the Planet. This is the time for those who have the capacity and the money to buy cheap shares. And the suspects here are, on one side, Saudi Arabia and other petromonarchies in the Gulf (which can give up anytime the oil incomes for some months) and, on the other side, countries always seeking energy, like China, Japan or South Korea. India, the third global oil importer, which pays annually $100 billion for acquisitions, could make it big now and even enter the big league. If they have or not the financial resources to do it, well that’s a different discussion.

The effects of such circumstances on the oil market can be huge. For some states dependents on the oil export which do not have sovereign funds in their pockets, this may be a major political crisis. This is the case of the Russian Federation and other states, such as Iraq, Iran or Nigeria. The Organization of the Petroleum Exporting Countries (OPEC), despite the current coordination efforts, could turn irrelevant. Not least, the energy industry, respectively the alternatives to hydrocarbon will go through difficult times.

Translated by Andreea Soare