What do negative oil prices mean? Not free petrol, it seems

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The oil industry was thrown into chaos on Monday as prices for US crude oil went negative, meaning that sellers were actually paying buyers to take oil from them, rather than the other way around.

Monday was the first time oil prices had ever dropped into negative, leaving many confused as to how oil could become valued at such a level despite being central to the global economy. Others have asked what the consequences could be, both for governments reliant on oil for their revenue, and ordinary consumers who fill up their cars with petrol.

Here are the answers to five of the most important questions.

How did this happen?

Oil’s nosedive to negative pricing was a result of two key factors. First, the coronavirus has caused an unprecedented drop in demand for petroleum products as people stay at home rather than driving their cars or working in factories, and airplanes sit dormant due to restrictions on international travel.

Secondly, as demand has fallen off a cliff, oil producers have continued to produce increasing amounts of oil. Talks between key oil producers aimed at rebalancing the supply and demand of oil broke down in March, leaving the production of crude oil massively exceeding demand from refineries to produce petrol and diesel – resulting in large amounts of spare oil that needs to be stored.

The world is running out of space to store this spare oil. As traders on the US market began to realize that there would be no space to put oil in once they bought it, a panicked selling frenzy gripped the market, and prices began to drop sharply.

As the situation got worse, traders, who often do not even have a place to put oil and are just trading the commodity electronically, ended up having to pay to get rid of their futures contracts because they had nowhere to store it – otherwise known as negative pricing.

Why would anyone sell products for negative prices?

Oil is traded in futures contracts that specify how much crude the buyer has obtained, and when it will be delivered. Between the open and expiry of a contract, typically a period of around a year, it can be bought and sold. Many investors buy and sell these oil contracts to make a profit, without ever seeing a physical barrel – a profession known as futures trading.

The situation on Monday was the result of these so-called “paper traders” being stuck with futures contracts that were expiring on Tuesday and required oil to be delivered in May – without anywhere to put the oil. Negative prices indicate that traders became so desperate to get rid of the contract that they would rather pay someone to take it off their hands than try and find a place to put the oil.

Does this mean I’m going to get paid when I fill the car up?

Unfortunately, not. The global oil market is wholesale market so prices for crude do not translate directly to consumers. The negative pricing applied only to one specific futures contract on one day and other benchmarks for crude oil, such as North Sea Brent, continued to trade at a positive value of about $20 a barrel. While prices for petrol and jet fuel may go down, consumers should not expect to receive a check for filling the car up.

Has it happened before?

Oil prices have never been negative before. The fact that prices went negative this week reflects the magnitude of the problem that the coronavirus pandemic has caused for the global economy.

While top producers have already decided to take measures that will see around 20 percent of crude supply removed from markets, the slump in prices suggests that even this may not be enough.

Okay, is there any history of negative pricing elsewhere?

Yes, it is actually fairly common in two other industries.

The first is electricity. The industry has had to regularly deal with negative pricing as the proliferation of renewable energy has grown. With wind and solar farms producing more and more energy, the market for electricity occasionally becomes oversupplied, dipping prices into negative territory.

As supply of electricity outweighs demand, and prices go negative, owners of traditional energy production plants – think coal or gas plants – have to turn off production. In this case, the price is a signal to owners that their energy isn’t needed, prompting plant shutdowns.

The second is natural gas. This fossil fuel is a byproduct of oil drilling. As oil is drilled out of the ground, associated gas comes up with it. Normally, this gas is then shipped to be used as fuel, but if heavy drilling is ongoing, then sometimes the transport network cannot keep pace with supply.

Drillers then have two options: Either they can burn the gas themselves, known as flaring, essentially wasting the commodity, or they can pay someone else to take it away. If this sounds familiar, it is because this storage and transportation squeeze is similar to what happened in the oil market earlier this week.

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