Giving away oil

Tuesday oil producers had to pay other parties to take their oil off their hands.  Well, not exactly.  What did happen is the price for May delivery of West Texas crude fell to -$38 per barrel.

So what gives?  Keep in mind these are futures contracts that are used for risk management; these are options to sell.  Oil companies purchase these futures to hedge against the risk of price drops.  For instance if the price of oil today was $30 per barrel and you were worried about the price dropping below $25, you might want to buy an option that lets you sell at a price of $28.  Most options are never exercised; they either expire or are traded.

On Tuesday there were not any buyers for May delivery at prices above zero.  This is happening because (1) global demand for oil has collapsed as people shelter at home to avoid COVID-19, (2) major producers such as Russia and Saudi Arabia have yet to cut back on production despite the demand situation, (3) it is costly to shut down a well so many producers have procrastinated, and (4) we are about to run out of storage space.

In a nutshell, a simple supply and demand story.  Looking ahead, expect prices at the pump to drop in the coming weeks, perhaps falling below $1 per gallon.  For more insight, see this video clip of my interview with local news channel WRAL.