Can Crude Oil prices go below zero? What was all the fuss about?
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What is WTI what is a commodity exchange Brent crude oil is the benchmark of oil in the international market meaning if you have to check the price of crude oil you need to check this benchmark similarly in the USA best Bank intermediate WTI is the benchmark for oil if you have to trade a contract of WTI you have to go to the commodity exchange of USA the New York Mercantile Exchange NY MX just like how shares of companies are traded in the stock exchange commodities like gold silver currency oil are traded in commodities exchange in India multi commodity exchange mcx is the major exchange if you wish to trade in the commodities market in the commodities market all the commodities have future contracts now let us understand what a future contract is with the help of a practical and comprehensive example let's rewind into time suppose in the month of February you get into an agreement with a counterparty and oil producer from North Dakota the concept is simple you agree to pay him $50 for one barrel of oil today and he agrees to supply you with in a green barrel in the month of May this deal is termed as wild future contract and you both sign off the deal there is a future contract every month for example April May June in this case since the delivery of the oil is in the future time of May so we term it as May future contract now you are not looking to actually buy the oil physically that would require you to take the delivery from the producer and store it also we are not talking about just one or two battles the future contract of WPI has a fixed quantity of 1,000 barrels meaning the day the deal was made you agreed to buy at least 1,000 barrels just to take actual delivery of it would not be a good idea so an idea strikes you and you do your speculation that between January to April the crude oil prices will go up let's say you suppose that price would touch $70 and there might be buyers looking to buy this contract of you as a result you would make a tidy profit however to sell this contract you have to do it before its expiry date every futures contract has an expiry date and every country has a different expiry date for instance in India all future contracts expire on the last Thursday of the month similarly and Miami X has set the expiry date form a month future contract as 21st April 2020 this implies that anyone trading with oil may future contract can either sell it before 21st April or take the delivery of the oil at $50 the rate at which the deal was signed off now the situation gets a little intense if you don't sell you a future contract you have to buy oil at $50 per barrel this deal will only be profitable if the crude oil prices go up otherwise your contract will be worthless fast-forward to March a talks between the Organization of Petroleum Exporting Countries OPEC and Russia collapsed the discussion was in regards to scaling down of production of oil so as to pop up oil prices since the talk has collapsed every country goes on aggressive mode they begin to ramp up the production the analysts from all over the world fear that it could trigger a price war with more production there is more supply
Which is getting stored at the refineries and the refineries are filling up fast one point worth mentioning here is that crude oil is not the end product you need to process it to convert it to patrol diesel or kerosene so unless the refineries have the capacity to process all these oils crude won't be put to ultimate use arrives the month of April that brought the dark clouds of doom the US has been severely gripped by the plate most of the u.s. is under lockdown in fact most parts of the world under lockdown and suddenly the demand for oil declines massively the world comes to a standstill the refineries are not able to transport the stored crude two industries so they start refusing the supply from the oil producers the unprecedented has occurred the producers are shying away from it the refineries do not want to touch it and lastly the consumers do not need it to the oil producers are not stopping their production well they can't there are two main reasons for it first stopping and restarting oil production is not as easy as it sounds it's a complicated and expensive process second every country has this fear that once they stop the other oil-producing countries are going to eat into their market shares by taking over their clients a very basic rule of economy states that the prices are determined by the demand and supply if the demand is more than the supply the prices go up and if the supply is more than the demand the prices go down now since the demand for oil is virtually zero and the production has not stopped the price of the oil will go down the situation is that nobody wants your future contract now even if you wish to sell it at a steep discount you start to ponder over accepting the actual delivery of the oil but there's a catch in that as well most of the crude oil in the USA ends up at the delivery point in Cushing Oklahoma if you decide to take the delivery you have to go to Cushing and take the physical delivery of the oil there once you are there you have two options either to use storage space as pushing back pain feel periodically or to transport your oil to somewhere else but where on earth would you transport and keep 1,000 barrels of oil so the best option for you is to play the required piece at Cushing and store your oil there with a hope that in a month's time when the prices go up you can sell it at a premium but there is a problem the storage at Cushing is running at high capacity also in oil storages there is no fixed storage price they often follow a dynamic pricing model wherein as the storage increases there is an uneven hike in price
The situation is such that the prices have reached sky-high and under such circumstances taking delivery transporting it and building your own storage is seemingly cheaper the other option is to take the oil and store it in large offshore containers floating somewhere near the coast of South Asia unfortunately they are also full well remember it's not just you but thousands of other traders who rush to sell the contract as they realize there is no storage space available they also cannot afford to store it on their own well now no one is interested to buy it nor sell it on 21st April the WTI crude opened at $18 per barrel and whether selling the price goes to $10 it dips to $5 and finally to $0 you cannot believe what you are seeing as you see the prices declining with the passage of time and soon it reaches a negative level with a heavy heart you sell your contract at minus five dollars per barrel meaning you'll be paying for the oil that you have sold meanwhile other traders are also selling pushing the oil prices further down to minus forty dollars for that thus this extensive example explains that the WTI crude was not trading at negative prices although the Brent crude was still hovering dangerously close to zero dollars per barrel it did not go negative since the world has not had the problem of storing excess oil yet but if they do not take measures to scale down production the Brent crude might also dip below the zero dollar mark all this havoc led to a massive fall in the share price of firms belonging to the energy sector in the United States let us move forward and address the impact of the entire situation on India the main concern that clouded the mind of people is how the drop in the crude oil price is going to affect the price of petrol and diesel will it be available at cheaper rates or not well on a practical note the chances of a decline in rates of petrol and diesel are very less and there are two main reasons for that first the value of rupee is constantly dropping against the value of dollar in the international market we can also say that Indian rupee is constantly getting weaker as compared to the US dollar a couple of months back one dollar was equivalent to 70 rupees but currently one dollar is nearly equivalent to 76 rupees this is a known fact that India is an importer of oil where it has to pay in dollars for all the oil it imports thus the weaker the rupee gets the more India has to pay for the imported oil further in India petrol and diesel do not fall under the GST category due to this the Indian government imposes high taxes on petrol or diesel to reap out its revenue and reduce the fiscal deficit for instance recently the government announced the increment of excise duty on diesel by 13 rupees a litre whereas on patrol the excise duty was real by 10 rupees Anita this step was taken to shore up the revenue that is not doing very well at last we can all look fool about the future and keep our fingers crossed about the entire covert 19 situation