Falling WTI Crude Oil prices what does it mean for the world economy?

US Crude Oil (WTI) prices fell more than 300% to settle at -$37.63/ barrel on Monday (20/04/2020). This sent shock waves across the markets as this is the first time in history that oil is trading at negative prices. What this potentially means is that oil companies in the US are paying buyers to buy oil from them. 

The Reason?

Reason for the same is the fact that these oil companies have to stock oil and there is an inventory holding cost that they have to bear. With the extended lockdowns owing to COVID-19 pandemic, nobody is consuming oil as the manufacturing facilities are shut, transport is not taking place, people can’t travel, etc. This means that these companies have excessive oil sloshing around and they are over-supplied and demand is absent. During such times, even the refineries won’t be willing to stock more as they also have to have customers who are ready to buy oil products from them otherwise, they will have to bear the burden of inventory holding costs. So, that’s that and therefore, oil companies have to choose a balance where they bear lesser costs than the holding costs and so it seems wise for them to spend in selling rather than holding.

But what next? Is it going to affect the prices that consumers pay?

No, it might not affect the prices that consumers pay on products or spend for their gasoline. This is primarily so because refining companies may still not be willing to sell their products at discounted rates and may continue to sell at the previous rates as they are already foregoing revenues due to weak demand and they are not buying the quantities of oil that they can’t hold.

Does it also mean that Brent Crude can trade at negative prices and if so, what happens next?

This doesn’t mean that Brent Crude can also trade at negative prices. It is primarily due to 2 reasons:

1.   The settlement of WTI Crude Contracts happens by physical delivery, whereas Brent Crude Contracts can be settled by cash payment. This means that a person doesn’t necessarily have to stock oil if he/she holds the Brent crude contract on the day of expiry. This leads to less sell offs of the contracts in case of Brent.

2.   Brent Crude comes from North Sea by extraction from dozen oil fields located there. This means that Brent is close to waters and can be stored in tankers. While WTI, produced in areas such as Cushing, Oklahoma, because of its landlocked nature, is quite far from the nearest water body. So, transportation of WTI crude is an issue, more so in these times.

But we may ask, if in a hypothetical situation Brent Crashes, what will happen in future?

Here’s the most dystopian thing that you are going to read now. The economy will have to start with the date 00-00-0000 again. Why so? Here’s an explanation:

Brent Crude is the most used oil globally. It works as a benchmark for pricing oil and thereby products globally. With Brent coming to zero, the component of oil price in the final product price becomes zero. Seems good no? Now all our products become cheap and we consume lavishly! But no, that’s not the case. Brent coming to zero potentially means market has crashed, no one is producing, no one is consuming, there’s no demand, no supply, no employment in the economy. This is what will drive Brent to crash. This means no currency holds any value, all those stacks of cash and money in banks have gone bust and whatnot. With this, we might have to start with the barter system again. Seems scary? It is scary.

In these times, everything is so inter-connected that workers losing jobs in US is going to impact India and all countries across the world. So, the cycle goes on: No jobs-No Consumption- No production- No jobs and so on and so forth.

What can we do? We can only trust oil cartels in this time, and trust that balance will be restored and prices will be maintained/rectified. Another alternative that I can think of is that refineries may stock up oil and wait for demand to pick up. They may also buy oil at zero price as such it is a valuable commodity and sooner or later the demand for the same will be there. But this too will be limited by inventory capacity and costs.