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The U.S. Oil Price Crash, Explained

How is it possible to have a negative price for oil? Here’s a breakdown of how oil prices dipped below $0.

Who knew that oil prices could be less than free?

In January 2020, the price of oil was around $60 a barrel. Yet on Monday, April 20, the price for U.S. oil settled at -$37.60 per barrel. This is the first time the U.S. oil benchmark, West Texas Intermediate, has closed below zero. That means producers are so overwhelmed by their supply that they are willing to pay to get rid of it.

The simple explanation for the price plummet is based on the first lesson of economics: too much supply, not enough demand. The oil price crash was a result of several forces working together in the weeks leading up to Monday’s trading session.

OPEC+ FEUD

Back in the first weeks of March 2020, members of OPEC demanded that Russia cut their production by 1.5 percent of the world supply to minimize overproduction. However, at the prospect of American oil production increasing, Russia rejected the demand. This meant the agreement between OPEC and other non-OPEC providers was set to expire by the end of March.

In the meantime, Saudi Arabia had absorbed more of the production cuts to convince Russia to stay in the agreement. In retaliation for Russia's exit from the OPEC alliance (called “OPEC+” or “OPEC-Plus”), Saudia Arabia announced its fight for greater market share by raising its output and slashing its prices on March 7. After weeks of tension, by mid-April, OPEC+ finalized a deal to cut about a tenth of the world’s supply and end the price war. However, the damage had already been done; there was now more oil than there was storage.

CORONAVIRUS COMPLICATIONS

There had already been a global impact on the demand for oil leading up to the OPEC+ disagreements. Before COVID-19, China would import about 10 million barrels of oil a day, making it the top importer in the world. In fact, that’s more than the next three leading countries ⁠— the United States, Japan, and Korea ⁠⁠— combined.

When the novel coronavirus strain hit China, millions of people in quarantine limited production in factories and restricted transportation. Not only did that affect the economy within China, it also impacted much of the economic activity that interacts with the country, including business operations, travel, and trade. That resulted in lower demand for oil throughout February and early March.

By March, the COVID-19 pandemic hit the U.S. The lower oil prices were no longer a rollover effect from China; at this point, nationwide stay-at-home measures limited business and travel, which severely cut demand for oil. And as of April 20, there weren’t many government officials or facilities in the U.S. announcing they would lift isolation mandates any time soon.

MAY FUTURES MARKET

There is a specific reason why oil prices plummeted on April 20: the May futures contract for West Texas Intermediate was about to expire. Normally, traders can sell off their contracts and roll on to the contracts for future months. Unfortunately, there weren’t many buyers who could accommodate that oil.

It wasn’t a matter of the price being low enough for the buyers; it was a matter of physical space. With the surplus in supply, producers were running out of storage space for crude oil. With the deadline for the futures contracts looming, that meant they were willing to pay buyers to take their oil away.

The timing of the contract close was one of the main factors why the price closed below zero. Although they traded lower, the prices for other types of crude didn’t drop nearly as much on that date.

As of this article’s publication, the U.S. has felt a bigger impact than other countries because they have higher transportation costs and, simply, they have run out of oil storage tanks. However, the oil price crash on April 20 is a result of projections for crude delivered in May. Moving forward, traders will begin to look at trading oil barrels for delivery in June, which could potentially have more optimistic forecasts depending on recovery from COVID-19. While it is too early to tell, there are several factors that could influence a different result for June contracts.

Sincerely,

The Team at Score Priority
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