HOW OIL PRICES BECAME NEGATIVE DURING COVID-19

Oil, undoubtedly one of the most invaluable resources in the present century, has not only built empires but also created generational wealth. With its current trading price hovering around $1 per litre, it may seem inconceivable to envision this precious commodity plummeting to extremely low levels. Yet, what if I told you that the unthinkable occurred—oil prices actually entered negative territory at some point? It might be hard to believe, but such a staggering turn of events transpired during the COVID-19 pandemic.

April 20th, 2020 marks the first day in the history of humankind, wherein oil prices entered in negatives.

US oil benchmark West Texas Intermediate (WTI) fell from $17.85 at the start of the trading day to (-) $37.63 by the close.

The onset of the COVID-19 pandemic played a pivotal role in this peculiar situation.

With lockdowns implemented worldwide to curb the spread of the virus, demand for oil dramatically contracted. People stayed home, resulting in a significant drop in oil consumption.

This led to a situation wherin the demand of the commodity i.e oil declined drastically, however the same commodity had an oversupply in the market.

Another contributor to this straneg occurance was the fact tha 'The Organization of the Petroleum Exporting Countries (OPEC)' and its allies had engaged in a price war, flooding the market with excess oil just as the demand shock from the COVID-19 pandemic hit. This oversupply, coupled with limited storage capacity, created a situation where producers were willing to pay buyers to take oil off their hands and in such a situation, the prices of goods enter negative.  Traders who were holding future contracts for physical delivery were faced with the daunting challenge of finding storage space or offloading their contracts at any cost, leading to the unprecedented negative prices.

It is to be noted that the negative prices were not sustained beyond that particular trading day, and subsequent futures contracts did not experience the same extreme downturn. Prices for future contracts and spot prices in the oil market eventually stabilized and began to recover as the global economy adjusted to the challenges posed by the pandemic, and efforts were made to address the oversupply issue in the oil market.

Key Lessons drawn:

Oversupply Challenges:

The negative oil prices were largely due to oversupply, mainly caused by the decision of major oil-producing nations, including those in the OPEC+ alliance, to flood the market with excess oil exacerbated the situation. Thus, the market failed to manage this oversupply and couldn't maintain a balance between production and demand.

Risk and Volatility in Futures Markets The event highlighted the risks and volatility inherent in futures markets, where contracts for future delivery are traded. The long term is full of risk and one must expect the unexpected.

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