We’ve seen a lot of strange and unusual market headlines these past few weeks. But what happened yesterday afternoon has to be the most bizarre yet.
That’s when the price of U.S. oil dropped by 321%, ending up in the negative.
That’s right. Oil producers couldn’t even give away their oil, so they had to pay people to get rid of it.
We’re not talking about small change here, either. The closing price for U.S. crude oil on Monday afternoon was negative $40.32 a barrel!
That’s right: -$40.32.
To think, U.S. oil was trading at positive $40 a barrel just two months ago!
Not only have U.S. oil prices never been below zero, to see them fall so much further shocked traders and investors. The S&P quickly tumbled from just in the green down to -1.79% at close.
It’s crucial that you know what exactly happened, why, and what’s next. That’s why we here at Profitable News have put together the most important questions about the oil collapse, and answered them.
Look below for that. And if you have any more questions or thoughts about this oil price crash, please leave a comment below. We'll do our best to answer them in a future post.
Q1: What does it even mean for the price of a good or a service to be negative?
A1: Usually, the seller hands over their product in return for the buyer handing over money. But when prices are negative, the buyer won’t take the product unless the seller pays them for it. So the seller hands over both the product and the money.
In this case, oil producers are paying oil buyers $40.32 for every barrel of oil the buyers agree to take.
As you know, in an idealized market the price of goods is set by supply and demand. The more supply there is, the lower the price; the more demand there is, the higher the price.
Of course, companies would want to make as much money as possible, so they abandon industries with low prices and flock to industries with higher prices.
So over time, low demand not only lowers prices, but also lowers supply as companies abandon that industry. On the flip side, high demand increases the price, which entices more companies to enter the industry. This leads to higher supply.
So in theory, negative oil prices make no sense. Oil producers should have stopped production when oil prices fell below their cost to pump the oil.
Q2: Isn’t crude oil necessary to running the economy? How can something so essential be more than worthless?
A2: A negative price for oil is indeed very strange. Oil accounts for 32% of the world’s energy supply, making it the most important energy source on the planet. It shouldn’t be priced as if it was less than worthless.
But this situation is unique, for three reasons.
First, it takes time and money to close off an oil well, and then to restart it again. This means it’s often cheaper to keep producing oil, even when you can’t sell it at a profit.
Second, the coronavirus pandemic has pushed global oil demand down by about 30 million barrels per day. But most analysts, traders, and oil producers expect that demand to start growing back in the next few months as economies start reopening.
So oil producers keep pumping because stopping would lose them more money. And they’re trying to stay alive until the fall, when prices pick back up.
Normally, they’d put the oil they make now in storage, and sell it later, at higher prices.
That’s where our third reason comes in. Because of years of overproduction from OPEC countries, Russia, and elsewhere, global oil storage started 2020 already pretty full.
Then the coronavirus pandemic hit, countries around the world began locking down their economies, and global oil demand dropped from 100 million barrels a day down to about 70 million.
Within a month, remaining oil storage was full. Even idle tanker ships have been turned into floating oil storage. But it’s not enough – and oil prices have turned negative, as producers are willing to pay not to have to shut their oil wells down.
Q3: Didn’t oil producers agree to a deal last week to keep oil prices from falling further?
A3: Yes, on Sunday, April 11, the OPEC oil cartel announced that it had reached a deal with other oil-producing countries, mainly Russia, to cut global oil production by 10 million barrels per day. But that still leaves crude oil supply 20 million barrels per day higher than demand.
Not to mention that analysts have serious doubts about whether OPEC will even stick to its deal. Past deals have all been broken, and there are enough loopholes in this one to sail an oil supertanker through.
Q4: How long until the price of gasoline falls to zero, or goes negative? I want to get money for gassing up my car!
A4: Me too, but unfortunately that’s not going to happen. It’s true that the coronavirus shutdowns have cut gasoline demand by about 50%. But the refineries that turn crude oil into gasoline are cutting their production, because demand is down and to allow more of their workers to self-isolate at home.
And with crude oil so cheap, refineries can afford to sell gas for very little and still make money. Expect lower gasoline prices, maybe even under $1 a gallon. But it won't become free.
Q5: When will oil prices recover, and by how much?
A5: By the time you read this, the official U.S. crude oil price – sometimes called “WTI” – will already be up above zero. That’s because crude oil prices are actually futures prices. A futures contract for oil is simply a deal between two parties that on a pre-established date, the buyer will buy the pre-established amount of oil barrels from the seller.
Monday was the last trading day for what was then the most near-term futures contract for oil, the contract for May delivery. And because demand is low and storage is full, no one wanted to have a bunch of oil delivered to them. They got so desperate to get rid of their futures contracts, they paid others to take it off their hands.
As of today, the contract for June delivery is the most short-term one, so it’s the one that shows up as the price of U.S. oil. As I’m writing this, that contract is trading at around $15 a barrel.
The contracts for months after that trade higher still. However, the pressures on the price of oil remain. China claims to have reopened after its bout with the coronavirus, but oil demand there is still down. Meanwhile, the staggered approaches that Europe and North America are taking practically guarantee that oil demand will stay low for longer.
And U.S. oil storage is on track to be completely full by the first week of May.
Oil is likely to stay below $20 for much longer. We may even see a couple more futures contracts ending in the negative.
It may be until the fourth quarter of 2020 or even next year until oil goes back to trading in the $30-$40 range.
Q6: Should I be concerned about this?
A6: As anyone who remembers the energy crises of the 1970s, expensive oil used to break the U.S. economy. On the flipside, cheaper oil should make all the things made from oil cheaper – gasoline, heating oil, plastics, pharmaceuticals, etc. That’s good for a struggling economy.
However, the U.S. shale industry has become a key part of the American economy, with about 9.8 million employees. According to the Dallas Fed, the shale industry alone drove 10% of U.S. GDP growth from 2010-2015.
At a time when the country is already struggling economically because of the coronavirus pandemic, this oil price collapse means extra pain for the oil-producing states in the Midwest and the South. The economic crisis won’t be limited to the dense coastal cities that have been hit hardest by the pandemic.
Q7: All this sounds pretty dire. How can this benefit me?
A7: Other than gasoline potentially dropping to $1 a gallon or below, there are also some simple ways to trade the oil price collapse. As I mentioned, oil will most probably be listed as being about $15 a barrel by the time you read this, because of the complicated futures contracts.
But as we talked about above, supply is still high and demand is still low. We may even see another drop below zero come late May.
Here’s how you can play this.
ProShares UltraShort Bloomberg Crude Oil (SCO) is an ETF that doubles and inverses the daily movement of U.S. oil prices. So when U.S. oil prices move down 1%, SCO moves up 2%.
On Monday, for example, SCO went up 11.39% in a single day.
Now, oil prices probably won’t make such a huge move for a bit. They’re likely to recover and stabilize a bit higher before they take another plunge.
When oil prices have gone up for a day or two on no real positive news, that’s when SCO is a good buy.
Editor-in-Chief, Profitable News