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The saga of Negative Price of Crude

A historic event occurred last week when the price of crude dropped below 0. Specifically, the value of WTI (West Texas Intermediate) went to a low of negative $37. What does this mean? Is Someone going to pay you to fill your car? Of course not, the fuel in your car and crude are distant cousins. The fuel which powers your car has a cost of refining and processing in it. Even someone sells crude for free, the cost of refining and processing is to be paid. Same as if steel prices drop to zero doesn’t mean that you can get a new car for free. The fuel is so important commodity and so much intertwined in our life that we certainly take it for granted. Most of the items we daily use like plastic, shaving foam, clothes, vitamins you name it uses crude derivatives. While These are just household items that we rely on day to day basis. The crude has unquestionable importance in each and every sector of our modern economy. Many countries are solely dependent on crude, black gold. So what happened last week and why a commodity so important and in so much demand selling at a negative price? There are many factors in this whole saga which include How crude is extracted, stored, and traded in today’s economy. Crude is extracted in parts in this globe but mainly can be categorized into three types. The crude from the gulf and middle Asia which we can call Oman crude, the second crude is extracted from the north sea near Britain, the Brent crude and third is extracted in the United States called WTI crude. Brent crude account for 2/3 of the total crude supply of the world. There is quite a distinction between Brent, Oman, and WTI crude. Apart from there different composition and characteristics, WTI crude is extracted from land while the other two are extracted from the sea. Only the price WTI crude went to the negative zone. Crude that is extracted from land sources is transported through pipelines to the storage area and is more costly from crude that is transported via sea routes. The WTI is transported to a single delivery point, Oklahoma United States, after it gets extracted. From there it gets transported to the different buyers of WTI crude. Recently due to coronavirus, many countries are facing lockdown and there is very little demand for crude. At the same time big mammoths of oil, Russia, and Saudi Arabia, are fighting a price war with each other. After the failure of negotiations on OPEC+, two of them started to show their dominance in the oil market by flooding the market with a huge supply of crude with intentions to ramp off the other from the oil business. It backfired to both of the nations and world economy sending ripples to the whole oil market in the world. As the demand plummet while the supply is on the rise the storage point of the land-based crude is filling up rapidly. That’s what happened in the Oklahoma where the tanks were filling in the constant pace but as there are no new buyers and the extracting companies comes into a position where they are ready to pay the buyer if they have the storage capacity to store crude. This scenario is only for the WTI crude and not with the Brent or OMAN because the latter is sea-based crude and has multiple delivery points and can supply crude to anywhere in this world. This is only one side of the story where we have the issue with storage of WTI crude but the way it gets traded among the buyers and sellers is what the main protagonist of this saga. Mostly there are two markets in which a commodity trades a spot market and futures market. In the futures market, the buyer and seller make a contract with each other to trade the commodity at specific price on a specific date. For example, A buyer says to the seller that I will buy 30 barrels of crude at $45 per barrel after 2 weeks. No matter what the price, less than or more than $45, the buyer is going to get the crude at $45 and the seller will sell the crude at $45 dollar. This provides certainty in the price of crude for both buyer and seller, and also for the producer of the crude because it knows that it has to produce 30 barrels in the next two weeks. This is a great method to be certain in a high volatile market but the issue comes when speculators jump in. Speculators are none among the buyer or the seller or the producer, they are only interested in making money by betting on the price. They get in the contract with either seller or the buyer without any intention of delivering or receiving the commodity. They are mostly large banks and investment giants with a huge pile of money to move around. In the crude market, they speculate on the price of crude and try to make a profit on their speculation. The spot price of WTI crude hasn’t touched the negative price but the May futures contract has. Some large speculators had huge contracts on the long side(buy-side) of the market after the positive news the settlement between Russia and Saudi Arabia which didn’t last long and they dumped a huge pile of futures contracts in the market driving the price of WTI crude to negative territory first time in history.

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