The global economic impact of the coronavirus is being reflected in the current oil prices, where we have seen the lowest price of oil in more than twenty years. This week, the U.S. marker West Texas International saw oil prices plummeting to negative amounts, which, as a result, has led to a price decline by 17% in the Asian Brent and by 40% in the international benchmark.
Due to coronavirus, the demand for oil has gone down, leaving oil traders, producers and storage facilities in havoc. So what exactly happened?
Futures Contracts
You must first gain an insight of how this type of trade operates. So, to start off, let's define what futures are. They simply are legal agreements (contracts) to buy and sell assets—such as commodities or securities—at a predetermined price and specific time in the future. The buyer of a futures contract is obliged to buy and receive the underlying asset when the futures contract expires. The seller of the futures contract, on the other hand, is obliged to deliver the asset, regardless of the current market prices on the contract's expiration date. Oil is an example of a commodity that is traded in this manner.
In the current scenario, for May 2020 contracts, the current oil prices were determined by using the shortest-term oil futures contract. The requirements of this contract are that oil should be delivered to a determined location between 1st to 30th of May 2020. In preparation for physical delivery of the oil, its trading contract and settlement closed on 21st of April 2020.
Today, 22nd of April, the price of oil might slightly change as we shift from the May 2020 contract to a new June 2020 contract, which will be settled on 19th of May and will be delivered before end of June. As you can now see, the actual trade is not on the tangible oil but on the contracts, in form of paper, that promise deliveries of oil in the future.
Storage
We are now at the end of the oil delivery phase. Coronavirus has created a low demand of oil globally. As per the futures contract, the actual oil must still be delivered to facilities, such as those in Cushing, Oklahoma, which are getting filled to capacity. Traders now have to physically find ways to take this oil and store it in other storage facilities, offshore tanks and even oil trucks. What then happens when all the facilities are filled to capacity? This is exactly what caused the negative price of oil earlier this week. There were traders who had not planned to physically have this oil delivered to them, and with limited storage and increasing storage costs driven by high demand, traders became so desperate and weary that they intended to pay other people to take the futures contracts off their hands.
Expectations
The low demand of oil has created a high supply in the market and difficulties in the oil storage facilities. Since coronavirus is still here with us, we expect the market to remain low in the short term as the world readjusts to the point where supply will meet demand.
In the coming few months, we (consumers) should expect a decline in fuel prices. The actual price of fuel constitutes costs, such as refining and distribution, that are added to the final price, and so the decline will be minimal.