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Used to track oil prices everyday while at Goldman Sachs (way back in 2016-17). Will use some of the gyaan I picked up to explain why crude oil prices fell below $0 yesterday in simple terms and also cover few other points around crude prices
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First, oil prices didn& #39;t fall below $0 globally. It happened only in US. Although it might touch zero globally based on few factors I will explain later
There are 2 indices that are used as benchmarks to price oil worldwide - WTI and Brent.
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There are 2 indices that are used as benchmarks to price oil worldwide - WTI and Brent.
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WTI is used to price oil extracted in US. And Brent is used for oil extracted in Europe, Middle East and Africa - hence making it more global (Brent dictates oil prices for ~2/3rds of global oil supply)
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It was WTI that went below $0. Brent is still trading around $20.
Ok but why do they trade at different prices? Firstly because quality of oil is different. WTI is & #39;lighter& #39; & & #39;sweeter& #39; than Brent oil. & #39;Lighter& #39; is preferred to & #39;heavier& #39; because it more expensive to refine.
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Ok but why do they trade at different prices? Firstly because quality of oil is different. WTI is & #39;lighter& #39; & & #39;sweeter& #39; than Brent oil. & #39;Lighter& #39; is preferred to & #39;heavier& #39; because it more expensive to refine.
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& #39;Sweeter& #39; is preferred to & #39;sour& #39; because it produces lesser sulphur residue (think of it as bad undesirable residue).
So ideally, WTI should trade at a slightly higher price than Brent. It used to actually, until Brent became costlier around 2011 or so
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So ideally, WTI should trade at a slightly higher price than Brent. It used to actually, until Brent became costlier around 2011 or so
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This get us to the second reason why they trade at different prices - because supply & demand vary in their respective regions. These changes in supply & demand can be driven by geopolitical events, production levels, etc
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In 2011, with arab spring on, there was fear of Suez canal being closed. Suez canal is an important route for transporting oil across africa, europe & mid-east. This bumped up Brent prices over WTI
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Another example - When US producers discovered a new style of extracting oil called & #39;fracking& #39;, they produced too much and WTI prices fell.
So coming back to why WTI went below $0.
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So coming back to why WTI went below $0.
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When price is at $30/barrel, I receive $30 when I sell a barrel. When price is at -$10/barrel, I pay $10 when I sell a barrel.
Now, why will I sell? Can& #39;t I just wait till prices rises and then sell?
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Now, why will I sell? Can& #39;t I just wait till prices rises and then sell?
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The problem is some people have to sell regardless of the price. They will lose more if they don& #39;t sell because they have will have to take delivery of the oil they bought and find storage for it.
Wait, what& #39;s all this? Time for us to understand how oil futures work.
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Wait, what& #39;s all this? Time for us to understand how oil futures work.
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An & #39;oil future& #39; is a contract I enter into today (say, April 20) where I promise to buy oil at a certain pre-decided price in the future (say, June 20).
Why would someone do that? To bring in some certainty around how much they will have to spend on oil.
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Why would someone do that? To bring in some certainty around how much they will have to spend on oil.
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Say I& #39;m a manf. who buys oil for my factory. I can lock in price of $30 today for my oil purchase 2 months later. 2 months later, I& #39;ll pay $30 (regardless of whether actual price is higher or lower) and take delivery of it, ie, actual oil will move from seller to me (buyer)
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I prefer it this way because my future expenses are more certain and I can plan accordingly
But then there are few people who don& #39;t need oil. They just want to make a bet on the oil price and make some money off that ("Speculative traders")
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But then there are few people who don& #39;t need oil. They just want to make a bet on the oil price and make some money off that ("Speculative traders")
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If spec. trader entered into oil future contract of 2 months at $30, 2 months later - he/she will just sell the contract to someone who actually needs oil at current price.
If current price is $35, he/she will pocket profit of $5. If price is $25, the& #39;ll pocket a loss of $5
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If current price is $35, he/she will pocket profit of $5. If price is $25, the& #39;ll pocket a loss of $5
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Spec. trader doesn& #39;t actually take delivery of any oil.
So a smarty trader (let& #39;s call him & #39;Bala& #39;) bought WTI oil futures in Dec 2019 with a promise to buy oil at say, $30 in Apr 2020. D-day arrived and price of oil was way below $30 because of lower demand due to Covid-19
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So a smarty trader (let& #39;s call him & #39;Bala& #39;) bought WTI oil futures in Dec 2019 with a promise to buy oil at say, $30 in Apr 2020. D-day arrived and price of oil was way below $30 because of lower demand due to Covid-19
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Since Bala doesn& #39;t have an intention of really buying oil, he has to sell the contract on D-day, even at a loss. Or he will be charged something called & #39;storage fees& #39; by the commodity exchange and that will increase his loss
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The problem was...no one who could actually take delivery of that oil in the US was willing to buy - either because they were shut down or they had reached full storage capacity.
But Bala had to sell. He was willing to give the oil away for free ($0) but still no one bought.
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But Bala had to sell. He was willing to give the oil away for free ($0) but still no one bought.
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Finally, Bala said "I will pay $40 to whoever take delivery of my oil". Someone agreed to buy and WTI index recorded a negative price for the first time in history.
Bala also saved himself by limiting his loss to $70 ($30 + $40). He& #39;d have been worse off had he held on
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Bala also saved himself by limiting his loss to $70 ($30 + $40). He& #39;d have been worse off had he held on
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Coming to Brent.
Brent hasn& #39;t touch zero or sub-zero levels because there are few people with empty storage in Europe, middle east, etc who are still buying. Once they start touching 100% capacity, we can possible see even Brent touch $0 or below
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Brent hasn& #39;t touch zero or sub-zero levels because there are few people with empty storage in Europe, middle east, etc who are still buying. Once they start touching 100% capacity, we can possible see even Brent touch $0 or below
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If some parts of the economy kickstart and demand for oil picks up before those people reach 100% capacity, then Brent might not head towards such unreal prices.
Just FYI, India buys oil from OPEC (a group of oil producing nations) which price their oil based on Brent
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Just FYI, India buys oil from OPEC (a group of oil producing nations) which price their oil based on Brent
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Okay bye. This thread got too long. Sorry for wasting your time
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Fin.
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Fin.
