On Tuesday 21st April 2020, history was made when the price of oil fell below zero for the first time, to an eye watering -$37.63 a barrel. This is worrying as the world’s most important commodity is losing its ‘value’ so quickly. So now the question arises, “Why would anyone pay to sell their oil?”.
What do Japan, Denmark, Switzerland and oil producers have in common? Negative prices. Although this is the first time in history that the price of oil has gone below zero, these three countries have been operating with negative interest rates as early as 2015. A central bank’s interest rate is basically the price of money for savers and borrowers. Click here to find out more.
The downward slide in the oil price started back in March from a price war between Saudi Arabia and Russia, the world’s biggest oil producers. Due to the collapse of a pact that had put limits on the supply of oil, both countries opened their taps and maxed out their output; the supply of oil had started to increase.
Unfortunately, this was not the only war taking place at the time as a deadly disease, known as COVID-19, had started to spread throughout the world into countries such as Italy, Spain, UK and the USA, and very quickly became a global pandemic. In order to slow down the rate of infection, national lockdown has been the default response for most countries, with varying speeds of execution. The public were initially encouraged, then ordered, to remain at home and do everything within their power to limit human contact. The result? A substantial hit to the economy as people spent less money. The demand for oil had fallen because of the decrease in its consumption in cars, aeroplanes and factories.
As the supply of oil increased and demand contracted, the storage facilities began to reach their maximum capacity. The traders who purchased thousands of litres of oil for delivery in May had no storage space left for more oil. For traders, selling at a negative price was better than taking a delivery of actual oil without any space to store it. If traders defaulted on taking delivery then it could result in the cancellation of their trading licence and consequently a poor reputation in the market.
Every cloud has a silver lining though and a real benefit for consumers will be the much-anticipated reduction of petrol prices over the next couple of weeks. However, the amount of tax applied to petrol will ensure any benefit is diluted. This is even more so as the government will need every penny of tax revenue it can generate following the never-seen-before stimulus packages put together to battle Coronavirus. It is just a shame that you aren’t allowed to go anywhere as far as a full tank of petrol could take you to.
Author: Shekhar Mehta
BA (Hons) Business Economics ● MSc Finance ● CFA Level 1 Candidate
Shekhar is passionate about all things economics, enjoys writing and is studying for his CFA exams in finance.