TOO MUCH OIL

The economics of negative oil prices

Oil prices continue to tumble as demand drops

In Summary

• Current predictions expect the decline in demand to reach as much as 29 million barrels in April, with May being potentially worse

•While producers are brimming in the commodity, the same is not being churned into markets for consumption

Among the industries hit hardest by the coronavirus pandemic is the oil industry. Traditionally characterised by high price volatility, the economic slowdown being experienced by numerous countries has exuberated its expected price volatility, with historic price swings being experienced in the global markets.

Illustratively, the COVID-19 pandemic has seen oil markets experience the highest single-day losses, as well as the highest single-day recoveries in the industry’s history. Further, Monday 20 April 2020 saw oil prices slip to unprecedented negative price regions, particularly in relation to the US market.

 

As discussed in earlier pieces in this column, basic economic theories of demand and supply play a significant role in global oil prices. Consequently, both demand-side and supply-side factors stand to adversely impact the price of the globally traded commodity, especially where economic equilibrium is not attained.

In the present instance, economic go-slows targeted at reducing the spread of coronavirus have significantly deflated demand for the commodity.

However, for the most part, the supply of the commodity has remained consistent at pre-COVID-19 levels thereby highlighting an oversupply of oil in the global markets. This necessitated the powers that be, that is OPEC, to arrive at an agreement to reduce global production of oil by as much as 10 million barrels a day – the largest production cut in the industry’s history.

However, industry analysts predict that the reduction in global oil production proposed by OPEC would not nearly be enough to offset the decline in the commodity’s demand. Current predictions expect the decline in demand to reach as much as 29 million barrels in April, with May being potentially worse.

While the above provides a basic overview of the oil price tailspins evidenced through the COVID-19 period, it does not explain how we arrived at negative oil prices.

It is pertinent to note, however, that negative oil prices are largely being evidenced in the US market alone, with respect to WTI – the oil price benchmark applicable in the US. Indicatively, the price of WTI fell almost USD 50 a barrel on Monday to trade at - USD 30 a barrel, while Brent fell about five per cent to trade at USD 27 a barrel.

With respect to negative oil prices, the same is primarily due to insufficient demand to meet the supply of the globally traded commodity.

As discussed above, measures aimed at curbing the spread of COVID-19 have resulted in a decline in demand, on the back of stabilized production. Consequently, while producers are brimming in the commodity, the same is not being churned into markets for consumption.

This requires producers to store the commodity as they await a receptive market or sell the same off at throw-away prices. However, as global storage capacity is currently at almost optimum capacity, producers are forced to sell the commodity at throw-away prices.

In effect, buyers of the commodity are being paid by producers to take the commodity off their hands.

Karen Kandie – MD IDB Capital