How did Crude Oil Turn Negative?
Let’s make one thing clear. Oil DID NOT go below 0- the Futures Contract for Oil did. So, expecting the nearest retail outlet to pay you when you buy oil or fill up your tank is naïve to say the least. WTI Crude Oil is trading close to $21- the May Futures Contract is the one that turned negative.
Now, let’s understand why oil slipped to negative- and how is it possible that an asset is priced in the negative.
Due to the current COVID-19 outbreak, most of the world is under lockdown. This means there is almost no consumption. Consumption is what drives oil prices, and since there is more production than consumption Oil inventory has been piling up.
Things have gotten so bad that there is almost no storage left for this excess Oil inventory to be stored.
Now, let’s talk about what happened on Monday, the 20th of April. The May contract for WTI Oil was set to expire. At expiry there is mandatory settlement. This means the buyer of the Oil contract will receive actual physical barrels as delivery and the seller will have to give the buyer these barrels of oil.
Every oil contract has a very clearly stipulated instructions for expiry with designated storage houses(warehouses). This means the buyer can only store his oil in the indicated warehouses. So, to make things clear again- NO you can’t take these barrels of Oil and store them at your house.
With these warehouses almost full, all buyers were trapped having no place to store their barrels of Oil. This made them exit their buy position right before expiry. To exit their position buy position, someone else had to buy these May Contracts from them. But, no one would want to buy with the mandatory delivery requirement and no way to store these barrels of Oil. So, all the buyers virtually disappeared causing the prices to go into negative territory. This meant you get paid to buy those barrels of oil. But, you would have to figure out how to store them. This is why you were getting paid almost $57 a barrel($20 for the oil and $37 for the contract expiry settlement value).