Question

Using the commodity futures pricing equation, show how an increase in storage cost gives rise to a negative futures price but from the formula an increase in storage cost increases the futures price. ( This is in relation to the negative prices observed in the futures market for oil recently )

Answer 1

F = (Spot + Storage cost) * e^(rt)

From the formula we can see that if the storage cost increases, the futures price increases.

But, recently futures prices for crude oil went below zero to trade in negative owing to increase in storage costs.

This happened very close to the expiry of the contract. On the day of expiry of the contract, the one who is buying the futures contract will have to take delivery of crude oil barrels and bear the storage cost until the crude oil is sold.

Due to the drop in demand for the crude oil, the prices of crude oil dropped significantly. The supply was huge and thousands of barrels of oil were stored. With no demand for crude oil, one has to store thousands of barrels of oil before the demand picks up. This increases the storage cost for the investor who is buying futures contract. So, the demand for futures contract fell. This caused the prices of futures contract to fall to zero and then below zero. Because storage cost exceeded the value of the crude oil.