Oil Market Update

If anyone had suggested last year that oil prices would be negative in a few months, not many of us would have taken such comments seriously. Yet, on Monday, April 20th, 2020, the financial markets presented another mind-stretching phenomenon: negative oil futures and negative oil prices. After observing negative interest rates a few weeks ago, it’s another unusual event that has rarely occurred in the past, as documented in Figure 1 and Figure 2 of $/ barrel of the past 150 years. 

There is a substantially different mechanism of interest rates imposition and oil price per barrel definition, however. Central banks manage interest rates, and they may opt for imposing negative interest rates to reach their monetary policy goals, for example, to boost the economy. Contrary to that, oil’s stocks are traded, and the market determines its price. 

How can we come to terms with the current situation and make some sense of it? What does it mean for the future of oil-dependent industries, for the financial markets and the economy?

To better understand the underlying causes and formulate probable outcomes, let’s recap the factors determining the oil price. Traditionally, experts recognize four major influencers on cost per barrel: demand/supply ratio, unexpected shocks, market speculations, and strength of the dollar.

In our current situation, not only does the market face an extremely weak demand as Covid19 lock-in continues, but it is also challenged by a massive oversupply because of negotiation escalation between Russia and Saudi Arabia in the first quarter this year. Allyn’s consulting team analyzed the oil price war for our readers in the article: “Oil price war amid Covid-19 anxiety”. In the week of April 12, 2020, after a virtual meeting of representatives of OPEC members and allies, the group finally agreed to a daily production cut of 10M barrels, amount exceeding historical quotas. We could observe the signs of stabilization as markets responded to the plan and jumped up. However, just two weeks later, reality speaks for itself. The overflowing petrol storage capacities cause never seen before negative costs when crude oil traded for negative $40/ barrel.

Since then, crude oil prices move back to positive territory, as shown in Figure 3, Crude Oil WTI (NYM $/bbl) Front Month. Factors that have all together helped the costs upward move are: US president Donald Trump announced 75 mil barrels would be added to the nation’s emergency reserve, oil producers are decreasing and shutting off production, and many governments shared plans to reopen economies. Yet, the economy will still have to deal with the negative impacts due to struggling oil-producing companies or oil-dependent industries and related furloughs and unemployment.

Contributor: Natalie Brandlova