What Just Happened With Oil Prices?

It has been a strange couple of months in markets and the economy as the COVID-19 pandemic has taken hold. However, arguably one of the strangest events yet happened earlier this week as WTI crude oil prices cratered in historic fashion. 

On Monday, crude oil prices tanked over 300%, falling into negative territory for the first time ever (data going back to 1946). When markets closed for the day, the price for a barrel of oil was -$37.63. This means oil producers were paying buyers $37.63 a barrel to take the commodity off their hands over fears that storage capacity might run out in May.

Looking at the chart below, courtesy of data from Investing.com, oil prices have fallen off a cliff. It is hard to believe that prices were around $150/bbl in 2008.

What caused this sharp drop? There were two main factors at play here:

1. Demand for oil has all but dried up as global economic shutdowns have significantly reduced the need for oil in the near-term. This has created a huge supply and demand disconnect, as suppliers have not been able to reduce production enough to keep up with plummeting demand. While large oil-producing countries recently agreed to production cuts for May and June, it was too little too late.
   
2. The way oil is typically traded, and prices are reported, is based on the futures market. While trading futures contracts is complex, just understand that futures are essentially standardized agreements to buy/sell an asset at a future date at an agreed upon price. Like anything else in the markets, futures prices can go up and down based on fundamentals and investor behavior (similar to stocks). A portion of market participants will use futures contracts to “lock in” prices to reduce the risk in their business (think airlines hedging against rising fuel costs). However, a number of investors use futures contracts to speculate, betting on potential price movements for profit in their portfolio. 
   These speculators, who aren’t actually in the business of receiving physical barrels of oil, have to get rid of their futures contracts before expiration, or they could get stuck with the obligation to take delivery of the actual oil. Tuesday (the day after this price anomaly) was the last day to trade futures contracts for oil to be delivered in May. To avoid taking delivery oil and incurring storage costs, many traders and speculators sold their contracts on Monday, resulting in a snowball effect that pushed oil prices further and further into negative territory.

So what does this mean for oil prices going forward?

While the outlook seems bleak for oil right now, prices are not expected to remain this devalued forever. As of writing this, current oil prices have bounced back slightly into positive territory, but are still at all-time lows at $14.28/bbl. When looking at the futures curve for oil prices, contracts expiring in January 2021 are trading around $30/bbl, with expected prices increasing the further out you look. 

Though this doesn’t guarantee rising oil prices, many experts agree once global economic lockdowns are eased it will naturally create higher levels of demand for the commodity. We will also be keeping an eye out for any potential news of further oil production cuts to reduce supply. While there are already some major cuts planned in the upcoming months, anything additional would help support prices in the short-term.

In the meantime, consumers can expect relatively low gas prices for the foreseeable future as everything plays out.

We hope you are staying safe and healthy, and look forward to chatting with you again soon!

Derek and Ben

Co-Founders and Owners of Aspire Wealth