Question

According to what you have learned from the International Equity Market and Derivative, why the price of oil future was negative on one day during the pandemic of COVID 19? Please explain using your knowledge of physical settlement of future contract.

Answer 1

Answer:

Due to the lockdown all around the world, the factories have been shut down, travelling has come to a halt, businesses are shut- all this has resulted into the reduction of oil demand. It is still hard to believe that the prices of oil has become negative for a day but it happened first time in the history.

Due to the falling demand, the production has been reduced but such reduction was far less than the decrease in the demand leaving the producers with a huge volume of oil and no buyres in the market. The producers were running out of the storage spaces for storing the oil.

Oil prices turning into negative started with a futures' contract for West Texas Intermediate (WTI). Oil future contracts means a specific time and place is decided for its delivery at a stated price to hedge against the price fluctuations. And since the storage capacities were already full, the physical delivery of oil was not the option for most of the buyers. Thus, the situation arose where the buyers are far more less than the sellers. Agreements for May were expected to lapse on April 21, putting most extreme weight on traders whose agreements were coming due. For them, selling at a steeply negative cost was better than taking physical delivery of oil since no one needs it and there are less and less places to put it.