My Two-Cents on Negative Oil Prices
By: Abdullah Al-Basha
Tags: Economy, Economics, Politics, Oil, USA

I got a text yesterday from a friend of mine informing me that Oil is being traded at $1. My first reaction was: Did you mean $10? But apparently, it was $1 indeed, and soon enough it fell into negative territory.

I couldn’t wrap my head around the fact that a commodity is being traded at a negative price, but then again does anything make sense these days?

I thought this is it. This is the end of the world as we know it, but I was mistaken.

Looking deep into it, West Texas Intermediate (WTI) was the only crude oil instrument being traded at a negative price, and this makes the case very specific. Brent was still being traded at positive, yet low prices, and so are other benchmark crude oil.

Benchmark crude oil is the petroleum that serves as a pricing reference for other types of oil and oil-based securities. The 3 main dominant ones are WTI, Brent, and Dubai Crude

The specific case of WTI

West Texas Intermediate is the main oil benchmark in North America as it is primarily sourced from the United States, and unlike Brent which could be delivered to any point in sea or land, WTI contracts are delivered almost exclusively to the town of Cushing, Oklahoma.

The storage facilities at Cushing and other inventory locations are apparently full due to a shortage in demand. This pushes producers to give money to storage facilities to store the oil, as keeping it with the producer means incurring more costs.

As a matter of fact, CNBC has published a report on April 1st predicting that oil prices could soon turn negative due to storage issues. In other words, it wasn't a total shock that prices went negative.

Crude Oil benchmarks are not traded at spot price, but rather in the form of futures contracts, which are legal agreements to buy or sell a particular commodity, asset, or security at a predetermined price at a specified time in the future.

It is noteworthy to mention that the financial instrument that was traded at negative prices is WTI May 2020 Futures, which is traded in NYMEX. The prices of different oil instruments fell down as well but didn't reach negative prices. The chart below shows other futures prices for WTI:

WTI Futures- As of 21st April 11:00 AM GMT

So in a nutshell, your country will still import its oil at around $20 a barrel. The negative prices are specific to the American market, and only applicable to a few future contracts that were settled at negative prices.

Implications on the US

Falling oil prices usually have a positive impact on the majority of industries, since it means lower energy costs for production. So, any industrial country should benefit from falling oil prices.

On the other hand, the US is the world’s largest producer of oil. Moreover, it is not a secret that oil companies are one of the main supporters of Donald Trump, and he had publicly pledged to support them, putting political pressure on the current American leadership.

What makes things worse for the American oil industry is its relatively high cost of production as it uses expensive extraction technologies like fracking. It seems that the Russian and the Saudis know very well that lowering oil prices might push the American oil industry out of business.

Oil Production Cost- Total Cost covers direct production costs, Capital expenditure, taxes, and other administrative costs

To conclude, the American oil industry which is politically aligned with Trump is under huge pressure, but other sectors of the economy are benefiting from these low prices, making it hard to know the net impact on the American economy. What’s for sure though, this is a major hit to Trump and his allies.

How is this affecting the Dollar?

It is well-known that the value of Dollar is closely linked with petrol. This dates back to 1945 when the Americans reached an agreement with the Saudis and other oil producers to sell their oil exclusively in Dollar, and that was the birth of the Petro-Dollar.

The relationship is inverse: as the value of the dollar falls, the price of petrol increases.

The price of petrol now is at a record low, which is mainly attributed to a shortage in demand. Nevertheless, this is also signaling that the dollar is somehow overvalued, raising the question of whether or not the value of the dollar is sustainable, and this is a political question not an economic one.

The dollar is in a bubble in economic terms. There is too much debt denominated in USD, and more of it is being printed to rescue the economy. Nevertheless, as long as the US is maintaining its position as the World’s leader, they can sustain the dollar as much as they want. Its value will get into question when other major powers decide not to trade with the dollar, and this scenario doesn't seem so far fetched now.

Does it all make sense?

No, it doesn't. Nothing makes sense these days. Commodities being traded at a negative price is a first in history. If anything, this shows the historical significance of the crisis that we are at. It is something that we haven't dealt with in our entire history.

In the depression of 1929 currencies were pegged to gold, so there was a ceiling on money printing and monetary solutions. Now, currencies aren’t pegged to anything, and the sky is the limit for financial innovations and monetary solutions. The only thing that matters is to maintain trust in a fiat currency by any means possible.

The Dollar is merely backed by military power, making it easy to peg all world commodities to USD, but the dollar is in a bubble, and the US is losing its military dominance as the world’s only superpower.

If you are interested to know more about how money work, you can check my article:

What will happen next?

Nobody knows. This is the biggest application of game theory in our lifetime, and there are too many players and variables to predict an outcome. Nothing is predictable. If anything, negative oil prices show us that the fundamentals of economics as we know doesn't work anymore.