Why were oil prices negative?

Published by Gaurav Gupte on

Oil is the most valuable resource which is used in almost every automobile in one or the other way. Aviation fuel, cars, trucks, tractors, ships, generators, and a host of many other. Oil is believed to be one of the most highly traded commodities on the planet. Quite honestly, we cannot survive without it! But can the prices of oil be negative? What that means is that a buyer is paid for buying oil!! How and why did that happen? As you are all aware, the Covid-19, also known as the Corona Virus, has forced most countries to go into a complete lockdown, with very little economic activity! There are no flights happening between cities, let alone countries. People are all staying at home, so there is barely any consumption of oil. With a massive reduction in demand, there is an oversupply of oil. In addition to this, there was a brief oil war between Russia and Saudi Arabia. Saudi Arabia and Russia have been the two largest oil producers for many decades. The Saudi Arabian Crown Prince was trying to negotiate a deal with the Russian Premier, Vladmir Putin, to reduce oil production to artificially keep oil prices high. As Putin disagreed, an enraged Crown Prince Mohammad Bin Salman vowed to increase production of oil to levels not seen before. The objective was to reduce prices to such levels, that the Vladmir Putin would be forced to negotiate with Saudi Arabia to get a good price for oil.  Saudi Arabia increased its oil production to almost 12 million barrels a day. However, the plan backfired. Russia vowed to fight back and it increased its oil production to 10 million barrels a day. With less demand and an over supply in the world markets, the cost of oil decreased from $50/ barrel to $20 in no time. Slowly the prices of oil crept even lower, to the teens, and then finally $0/ barrel. This then went lower, to -$40/ barrel!! Oil fields/ wells across the globe cannot just be turned off and on like a tap as one wishes. An Oil and Natural Gas company has to gradually reduce the oil production from oil wells gradually. A sudden shutting down could result in the well getting damaged. The company could lose access to the oil underground permanently. Therefore, Petroleum companies have to keep pumping oil for quite sometime till they reach an optimum level for reducing or pausing production. With oil refiners and countries unwilling to buy oil, and global storage facilities getting filled up fast, Oil & Natural Gas companies had to ensure that the oil they pump is stored or consumed. With a reduced demand and storage, these companies had to literally pay buyers to get the oil off their hands. This is what pushed the oil prices into the negative zones! Similarly, there are many commodity traders who buy oil at cheaper rates and sell it back to refiners or others at a time when the prices are high. The commodity traders don’t need to take physical delivery of the commodity as soon as they buy it. They are allowed to sell it back to another party in a certain amount of time, without taking delivery of the product. Now, they will have to take physical delivery of the oil, if they don’t sell it in this time. In order to avoid taking physical delivery of the oil, commodity traders are also offering to pay the buyer money. Imagine if you are a country or a corporate that depends on oil for survival! Filling up oil reserves will be an absolute priority for you, as you are getting paid to actually do so. However, the challenge today is that most oil reserves are now full. Governments were already filling up their reserves when oil prices were in twenties. Nobody expected the prices to fall further and become negative. Now, there simply isn’t any more demand and people aren’t using a lot of oil. Follow our blog for more intriguing topics. Catch us on Facebook, Linkedin and Twitter.

Categories: EnergyFinance

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