Why global oil prices are going topsy-turvy
April 21, 2020
What is happening to the oil market?
Oil prices have fallen drastically over the past several weeks as a result of the coronavirus pandemic. Disunity among OPEC and other oil-producing nations has added further uncertainty to the market. Moreover, the fact that global storage facilities were full when contracts for oil deliveries were due early this week meant that no — or too few — buyers could physically take possession of oil that had been extracted from the earth. On Monday, all of those factors collided, driving prices for West Texas Intermediate (WTI) crude oil into negative territory.
How are oil prices set?
Oil prices are based on the concept of supply and demand. With the world economy at a standstill due to the ongoing coronavirus pandemic, demand for oil — and thus, the price — has fallen dramatically. Companies are ordering less oil, airlines aren't buying fuel because their planes are grounded and no one is purchasing gasoline or diesel fuel for their cars because most commuters are stuck at home.
Read more: Energy market upheaval puts LNG buyers in front seat
Which contracts pushed prices over the edge?
Futures for the month of May came due on April 21. Oil futures are contracts that let buyers and sellers coordinate the physical delivery of crude oil at a specific date in the future. That means anyone who owns futures on that date owns the oil, and they have to have some place to store it. That storage space also has to be paid for. At the moment, however, global storage capacity is practically full, leaving very little room to store May deliveries. Prices for precious remaining space have naturally risen. Fearing they would get their fingers burned, investors desperately tried to get out of the contracts. The futures became worthless in an instant, sending prices into free fall.
Did speculators cause the crash?
Yes and no – futures can be attractive for speculators because they are essentially bets on future pricing. And like any bet, you can win, or you can lose. In this instance, speculators gambled and lost big. But many companies also have to insure their commodity market activity, and futures are part of that practice. That goes not only for oil, but also other commodities like corn, wheat, soybeans and coffee. Futures generally offer a reliable and calculable price for a given commodity at some point down the road. But right now, no one wants to take delivery of the oil they own through their futures.
Read more: Where does Russia stand in the oil market turmoil?
Why is WTI the only product affected?
Unlike European North Sea Brent Crude, one of the defining characteristics of WTI is that it is only delivered to one place. That place is Oklahoma, home to the world's largest oil storage facility. All WTI pipelines lead to massive tanks in the city of Cushing, but most of them are almost full and the little space left in Cushing is selling at $10 (€9) a barrel and rising.
Why don't oil producers simply slow production?
The physical characteristics of oil production generally make it necessary for a well, once tapped, to keep flowing into world markets until it runs dry. It is difficult to just turn off a well, and that is especially true when it comes to the environmentally controversial technique of hydraulic fracturing, or fracking. That is one of the main reasons oil tankers on the world's oceans are now being used as floating storage facilities.
What does all of this mean for oil companies?
They may be in dire straits if the market doesn't correct itself. That could lead to defaults on loans as well as mass layoffs. Right now, the entire US fracking industry is looking into the abyss, as experts estimate companies need prices of at least $50 a barrel for them to turn a profit.
Read more: Oil and gas companies exploit coronavirus to roll back environmental regulations
Why is Trump buying oil now?
The short answer is: to grab headlines. The US president recently announced that he would purchase 75 million barrels of oil to prop up prices and top off US strategic oil reserves. Still, that does nothing to influence overall demand, and the move is a proverbial drop in the bucket, as 75 million barrels more or less equals global demand for oil for just one day. OPEC's decision — along with other oil-producing nations such as Russia — to cut daily production by 10 million barrels a day will have a much greater effect.
Nevertheless, most experts agree that none of those moves will be nearly enough to make up for drops in demand. Ultimately, that equation puts enormous pressure on countries like Saudi Arabia and Russia, both of which are hugely dependent upon oil revenues to finance themselves.
What does this all mean for the price of gasoline and heating oil in Germany?
Not much unfortunately, because taxes and duties make up more than half the price of both products in Germany. Though prices for Brent Crude also fell dramatically this week, they are still hovering around $21 a barrel. If prices for heating oil and gasoline fall, they will do so later and not by much.