ACTIVTRADES WEEKLY

By Ricardo Evangelista

www.activtrades.bs

Many of us watched in disbelieve last Monday night as the May future contract of crude oil was, for the first time in history, negotiated at a negative price. Traders offered to pay any buyers $40 per barrel, provided they accepted delivery at the end of May. A surreal and counterintuitive situation; how did the so-called "black gold" go from being priced at $65 per barrel at the beginning of the year, to producers paying anyone who would take their product off their hands?

As is usually the case, there is more than one reason for such a remarkable shift in market dynamics. During the last decade, global oil production grew to new highs in order to meet increasing demand, in particular from China. This scenario meant extraction methods, such as shale and tar sands, previously overlooked due to the high costs, became economically feasible. This process led to the United States becoming self-sufficient and eventually the world's leading oil producer, with other countries like Canada also extracting ever larger quantities of the fossil fuel.

To compound the market saturation effect - which would end up driving down prices - traditional leading exporters like Saudi Arabia and Russia increased their output in an attempt to, as prices dropped, price-out competitors by making the more expensive extraction processes unappealing.

Because production kept increasing, at a faster pace than demand, the new decade started with oil storage facilities already close to full capacity. And then, the first big shock happened in January; as the coronavirus emerged in China and the country imposed draconian lockdown measures to its economy, trying to halt the dissemination of the disease. As a result there was an abrupt drop in demand which caused the price to fall more than 15 percent.

As January became February and then March and the Chinese coronavirus outbreak multiplied itself into a global pandemic, many other countries also brought their economies to a virtual standstill, causing an unprecedented contraction in demand for oil and its derivatives. At the same time, the world's leading exporters failed to agree on a sufficient decrease in daily production, meaning that eventually there was more oil available than could be used or even stored.

The numbers are staggering: the global decline in demand is estimated to be in the order of 30 million barrels per day, while the daily production was reduced by only ten million; the calculation is simple: there is a surplus of 20 million barrels of oil per day, for which storage needs to be found.

This is why the price for the future contract of crude oil, with delivery in May, dropped to such lows last Monday: with market close approaching, many traders found themselves faced with the obligation to receive a product they were unable to sell or store, and because of this, in desperation, they came to the point of paying $40 per barrel to anyone able and willing to accept the delivery.