Demand for crude oil has been declined marginally as most of the countries are locked down and people are not allowed to travel. The spread of this pandemic has really broken the spine of the world economy because of which many industries are bleeding badly. The price of one American oil futures market contract plunged recently into negative for the first time in history. Theoretically, this means that the sellers, now, have to pay buyers to get some load off of their back.
Firstly, please accept my apologies for breaking your dream of buying gasoline for some pennies. It was never going to happen anyway. The main reason being prices of crude oil accounts for only about a third of the cost of gasoline and diesel at the pump. Refining, distribution costs, and taxes account for major chunk of the final price.
The price of crude oil depends upon various factors such as supply to demand ratio, storage capacity, and quality. The coronavirus outbreak has forced people to stay at home, which resulted in a sharp decline in demand. On the other hand, the supply to the market has not stopped, hence the excess supply.
Click here to read How Coronavirus Is Impacting the World Economy?
As we know, the May U.S. oil futures contract has plunged below $0, whereas International oil hasn’t been hit nearly as hard as its American counterpart. So what does this really mean? What is the difference between American oil and International oil mentioned above? Before going further, let me enlist some popular benchmarks accepted throughout the world. Benchmark crude is crude oil that aids as a reference price for buyers and sellers of crude oil. The benchmarks or the price of crude oil is decided based on oil’s physical characteristics, and transportation costs.
- WTI (West Texas Intermediate) – WTI is primarily used in the US. It is light (high API gravity) and sweet (low Sulphur). However, the storage of WTI oil is limited to the US as well as landlocked.
- Brent Crude – This is predominantly used in Europe. As it is priced in the North Sea, the storage for Brent is ample and far more accessible.
- Dubai Crude – Dubai Crude, also known as Fateh, is a comparatively heavy and sour crude oil extracted from Dubai. It is produced in the Emirate of Dubai, part of the United Arab Emirates.
- Indian Basket – it is also known as Indian Crude Basket. It is weighted average of ‘Dubai Crude’ and ‘Brent Crude’ oil prices.
What Really Happened
Crude oil is one of the most desired markets of futures day traders. This commodity affects the price of many other commodities, including gasoline, diesel, and jet fuel, etc. The undulation effect of crude oil prices also impacts the price of stocks, bonds, and currencies around the globe (*coughs* sometimes triggers the war *coughs again*).
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The price of U.S. oil which is to be delivered in May rushed below $0 on Monday, 20th April 2020. Tuesday was the last day of trading, and everybody wanted to hand off their reserve. Due to sluggish demand and excess supply, the main U.S. storage hubs are expected to fill up sooner. Very few traders wanted to be stuck with oil barrels that they have to take physical delivery on at some point during May. The June WTI contract is currently trading, which makes it a much more accurate measure of prices.
This fall mostly affect the companies like Exxon Mobil, Royal Dutch Shell, which employ thousands of professionals around the world, a lot of money to refine the crude and transport the products to various gas stations.
Click here to read Oligopolistic Nature of Oil
Reasons for this downfall
- The United States has seen its oil storage capacity to fill up fast because of sudden drop in demand by airlines and other buyers.
- The firms with the ability to store oil (e.g refineries) are not buying anymore.
- As sellers scrambled to dump May contracts, futures prices nosedived.
- Borders of most producing countries are closed.
Why Negative Oil Prices Does not Mean Free Gasoline?
The prices for WTI and Brent Crude, as of writing this article, are $16.94 and $21.44 per barrel respectively. Both of these benchmarks were priced at around $65 per barrel on the same day last year. So, you can understand how Covid-19 has really affected the industry.
Crude oil is only the initial ingredient from which refineries make gasoline, diesel, jet fuel, and other products. And the price of crude — even if it rushes down to negative value— accounts for only a fraction of the cost of the gasoline or diesel you put in your car, bike or truck.
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