US oil futures price below $0/barrel.
The WTI crude oil May month futures went below zero and even touched as low as -$37.63/barrel on the last day (i.e April 20, 2020) of contract expiry. But before proceeding let's get to know what is WTI crude, futures contract, etc.
WTI (West Texas Intermediate) crude is the benchmark of US crude oil and thus used to price crude extracted in the US, like the Brent crude is used as a benchmark to price crude oil produced in Europe, Middle East, and Africa. The quality of these 2 types of oil are different and WTI is considered superior to the Brent crude since it's less expensive to filter and produces less undesirable residue.
Let's go back in time say it's February and you can make an agreement with an oil-producing company in the US to deliver you the WTI crude in May at $40/barrel and you expect the crude price to go high above $40/barrel in May. Now, tell me will you hit this agreement? Mind it you are not an oil producer or refiner you just want to cash your speculation so what you do is to buy the crude oil at $40/barrel and sell it at the price prevailing in May. The profit you make is: Sell Price-Buy Price. If the crude price in May is $50/barrel you earn a profit of $10/barrel, say if it's $30/barrel you make a loss of $10/barrel. These traders are called speculative traders.
Since these transactions are facilitated through an exchange, here The New York Mercantile Exchange (NYMEX), it is called "futures" contract.
What's the present situation?
I hope you remember Saudi Arabia and Russia's oil price war? If not, Saudi Arabia pumped too much oil and rolled down the oil price resulting in a huge loss for oil-producing countries. This was all meant to comply Russia with the terms of OPEC. The oil price war has been settled but anyway, this resulted in a huge supply of oil into the global market.
Now, most of the countries are locked down there is no commutation, the global oil demand has plummeted, no oil producers want oil, no refineries want oil, basically, the US has stored oil to full capacity, and now no one wants oil.
A very classic example of supply-demand mismatch. Supply >>>> Demand resulting in a price drop.
Now the final day comes i.e 20th April 2020, the contract expiry day and you have to make a decision.
You have 2 possibilities:
Case 1: Let the contract mature and receive the delivery of WTI crude in May at the prespecified price of $40/barrel (say)
In this case, you are willing to receive the physical delivery of WTI crude but alas it's not like any other commodity which will be delivered to you to store in your kitchen, balcony, or in your backyard, you never know if it catches fire may even burn half the neighborhood. Don't confuse you are not buying just a barrel, a futures contract has "a lot", 1 lot = 1000 barrels (say) and you have to buy n lots. That's a huge quantity, isn't it?
It's delivered at Cushing, Oklahoma in the US, a specified location for oil storage in the US and since most of the countries are halted the world demand for oil has fallen significantly. Cushing is already working at 80% capacity and there is a huge surge in storage demand resulting in an exorbitant storage cost. So, you pay the guys at Cushing for storage and transportation of your crude oil till you are able to sell it.
Case 2: Sell your contract to someone willing to buy the crude oil.
Since there is no-one to buy your crude oil i.e no demand, everyone wants to sell, the WTI oil price starts flirting with $0/barrel, in a blink of your eye you see it trading at $5/barrel, but it's the price you pay to sell your commodity.
You witness unprecedented events with every trade execution and you decided it's better to even pay some dollars to sell your contract rather than to pay exorbitant price transporting and storing the WTI crude oil at Cushing, Oklahoma. So, you click the sell button at NYMEX and your order got executed at -$10/barrel.
The clock is ticking, we are moving to the contract expiry time.
-$15/barrel
-$20/barrel
-$25/barrel
And one of the orders executes at -$37.63/barrel.
Unprecedented !!! Bizarre!!! Uncommon!!!
An event to be remembered forever.
WTI (West Texas Intermediate) crude is the benchmark of US crude oil and thus used to price crude extracted in the US, like the Brent crude is used as a benchmark to price crude oil produced in Europe, Middle East, and Africa. The quality of these 2 types of oil are different and WTI is considered superior to the Brent crude since it's less expensive to filter and produces less undesirable residue.
Let's go back in time say it's February and you can make an agreement with an oil-producing company in the US to deliver you the WTI crude in May at $40/barrel and you expect the crude price to go high above $40/barrel in May. Now, tell me will you hit this agreement? Mind it you are not an oil producer or refiner you just want to cash your speculation so what you do is to buy the crude oil at $40/barrel and sell it at the price prevailing in May. The profit you make is: Sell Price-Buy Price. If the crude price in May is $50/barrel you earn a profit of $10/barrel, say if it's $30/barrel you make a loss of $10/barrel. These traders are called speculative traders.
Since these transactions are facilitated through an exchange, here The New York Mercantile Exchange (NYMEX), it is called "futures" contract.
What's the present situation?
I hope you remember Saudi Arabia and Russia's oil price war? If not, Saudi Arabia pumped too much oil and rolled down the oil price resulting in a huge loss for oil-producing countries. This was all meant to comply Russia with the terms of OPEC. The oil price war has been settled but anyway, this resulted in a huge supply of oil into the global market.
Now, most of the countries are locked down there is no commutation, the global oil demand has plummeted, no oil producers want oil, no refineries want oil, basically, the US has stored oil to full capacity, and now no one wants oil.
A very classic example of supply-demand mismatch. Supply >>>> Demand resulting in a price drop.
Now the final day comes i.e 20th April 2020, the contract expiry day and you have to make a decision.
You have 2 possibilities:
Case 1: Let the contract mature and receive the delivery of WTI crude in May at the prespecified price of $40/barrel (say)
In this case, you are willing to receive the physical delivery of WTI crude but alas it's not like any other commodity which will be delivered to you to store in your kitchen, balcony, or in your backyard, you never know if it catches fire may even burn half the neighborhood. Don't confuse you are not buying just a barrel, a futures contract has "a lot", 1 lot = 1000 barrels (say) and you have to buy n lots. That's a huge quantity, isn't it?
It's delivered at Cushing, Oklahoma in the US, a specified location for oil storage in the US and since most of the countries are halted the world demand for oil has fallen significantly. Cushing is already working at 80% capacity and there is a huge surge in storage demand resulting in an exorbitant storage cost. So, you pay the guys at Cushing for storage and transportation of your crude oil till you are able to sell it.
Case 2: Sell your contract to someone willing to buy the crude oil.
Since there is no-one to buy your crude oil i.e no demand, everyone wants to sell, the WTI oil price starts flirting with $0/barrel, in a blink of your eye you see it trading at $5/barrel, but it's the price you pay to sell your commodity.
You witness unprecedented events with every trade execution and you decided it's better to even pay some dollars to sell your contract rather than to pay exorbitant price transporting and storing the WTI crude oil at Cushing, Oklahoma. So, you click the sell button at NYMEX and your order got executed at -$10/barrel.
The clock is ticking, we are moving to the contract expiry time.
-$15/barrel
-$20/barrel
-$25/barrel
And one of the orders executes at -$37.63/barrel.
Unprecedented !!! Bizarre!!! Uncommon!!!
An event to be remembered forever.
Nicely explained
ReplyDeleteNicely explained
DeleteSimple and good explanation, the writing can be more clear.
ReplyDeleteOkay noted.
Delete