Oil Traders Killed : Once in Life time Image

Some are getting killed by Coronavirus and some are getting rogered by Corona effect and one such effect being seen is that countries don't have a storage facility for crude. May Futures are selling in negative. This is History being created. You must check Implications crude crash for India here.

You are all seeing the news flash talking about oil price going negative. So here is a very brief simplified (BUT NOT SIMPLETON) explanation for what's happening :

1. Most of the oil is traded via Futures Contracts. There is a Spot Price as well, which is taken into account while arriving at the "theoretical futures price"

2. There are two main Futures Contracts (remember this is simplified) - The WTI and the Brent

3. WTI refers to the Oil from North America, while Brent refers to oil from Middle-east, Europe and Russia

4. There are a million variants, but we will omit those for the moment, since they complicate the discussion without really adding any clarity

5. The "Oil Price" that's gone negative is the settlement prices for the May 2020 Delivery Contract (ONLY THAT ONE)

6. Some more complexity - There are two forms of settlements for Crude Oil Futures Contracts (and for most commodities), viz Net Settlement and Physical Delivery

7. Net settlement allows the buyers of the contracts to settle the financial difference between the buying price and the settlement price

8. If a buyer of a Futures Contract doesn't opt for net settlement on or before the "Notice Date", which passed last week for the May 2020 Delivery, then they are assumed to be taking physical delivery of the underlying quantity of Crude Oil

9. And that's the "technical problem" that's pushing the settlement price of May 2020 Delivery Contracts to become negative. There is a buyer, or a series of buyers, who are stuck with physical delivery option that they can't actually use, ie they can't take physical delivery of the underlying crude oil because they don't have the storage capacity to store this

10. The negative price indicates that they are getting some buyer, probably a refiner, or a storage facility or a driller, to take the delivery off their hands by PAYING them to buy the oil that's ready for May delivery

11. It's never happened before in the history of Crude Oil Futures trading. It's a very unique situation

12. However, the June delivery WTI futures are still trading in positive territory at $20+/ BBL. And the Brent Futures for June 2020 delivery are trading at $25+/ BBL

13. Will this have implications: surely so. It means that the US Crude Oil producers are now facing a glut and if they don't stop drilling, they will have to give the oil away free, and/or pay people to buy that oil.

14. This oil can't be dumped or disposed off, since that will cause an environmental disaster and result in billions of dollars of penalty (Exxon Valdez, Deepwater Horizon, etc.)

We can explain it with another analogy as below:

Imagine the following...you pay $500 today and commit to receiving an escort at your house in 15 days. Cos your wife is traveling. This is called a futures contract.

Unfortunately, lockdown came and your wife will be home for the next 60 days.

You do not want this woman to show up at your house at all and try to pass this futures contract to someone else.

Only you cannot sell this commitment because nobody can receive the escort at home anymore. Everyone is in full storage with the wife.

To make matters worse, not even the pimp (Chicago Mercantile exchange) has more room to receive girls because his house is crowded with girls.

So you will pay anyone just to take the girl off your hands.

Do you now understand why oil has a negative price when the contract is delivered? Hope it answers the Query that why WTI Crude Oil traded at minus -$37

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