Question

Explain the reasons for observing negative price in the oil future market and discuss its effects on the financial markets.

On April 20 2020,oil prices went to negative $37

( coronavirus effects)

Answer 1

The oil prices going negative was a side-effect of lower demand for oil all over the world. Many of the biggest consumers of oil are under lockdown currently and industries and domestic consumption etc have been greatly reduced. But, the negative prices of oil was for only a specific variety of oil and had reasons for the price going negative which were slightly different. The oil was Western Texas Intermediate (WTI) crude which is a specific grade of crude found in the US. Even if an asset becomes completely worthless, which oil has not, the price should not go negative. A negative price means that the buyer of the asset gets paid to buy the asset. No transaction in the world can ever happen this way unless the seller wants to explicitly get rid of the asset. This is what happened with the WTI crude. When the WTI prices were lower but poisitive, many oil traders who physically trade and transport oil, hired oil tankers and ships and filled them with oil so that when the price goes up and the situation improves, they could sell the oil and make a profit. This led to the booking of almost all oil tankers available in the region. Now, since there weren't any tankers left, the oil which was coming to the region had no place to be stored. The producers of oil couldn't afford to keep it with them. They had to get rid of the oil they were holding at that time. This drove the oil price down by a huge amount and it ultimately resulted in the negative prices of WTI crude.

Its effects on financial markets were also very bad. Those industries which use oil as a raw material could see gains for them but soke of them were already hedged. So, they could either let this opportunity of lower oil prices slide or use it by renegotitating the contracts. As such, the prices of other varieties of crude like Brent etc were positive at the time and were at $15-20 per barrel.