Question

Answer these based on john Hall text book The price of oil fell to an unprecedented level during the Monday April 22nd 2020 trading session creating major disruption and fear among oil producers and traders. Give extensive answers to: 1. How did the derivatives market facilitate process of negative oil prices? ( relate with futures pricing formula ) 3. What advice would you provide to oil producers for the next contract expiration?

Answer 1

(1) why did the oil price go negative ?

THE CONCEPT - IN GENERAL

• The places were Oils are storaged are almost in full capacity now and cannot accomodate more.
• If you have oil and do not find a place to store it, it will have no value or a limited value only.
• Already full tanks and an absence of a sharp demand return, will force the companies to cut production more rapidly.

THE FACTS OF THE GIVEN CASE

• The year opened with a price of $61 a barrel, but by the end of March,the prices fell to $23 a barrel. Even if this price was maintained till end of 2020, it would eliminate about 0.25% of GDP, and reduce the investments in business to 2%.
• On April 20, the prices further went down  to minus $37.63 a barrel (for futures contracts expiring on April 21) .Spot prices and Prices for Brent, fell down creating a situation of panic and leading the oil producers and traders to dump a huge amount of the futures contract.

(2) THE NEW NORMAL

• One probable reason to hedge is that with different methods of storages such as physical and floating storages, oil tankers and other facilities, oil will come back into game in the market.
• The price per barrel will rise.
• While providing for a chance of changing norms of companies in general, that is providing employees with work from home or reducing the number of days to attend the regular office might decline, but hopefully the aviation industry will compensate for this.