The coronavirus pandemic has shocked the global economy and Monday’s historic plunge in the US oil price is the latest twist in what has been a dramatic few months. The price of May futures contracts for one barrel of West Texas Intermediate oil, the US benchmark crude, sank to a record -$37.63 – an unprecedented lurch into negative pricing territory -- reaching a single-day drop of 306 per cent.
Soft demand due to worldwide coronavirus lockdowns and an earlier lack of agreement between major producers including Russia and Saudi Arabia on what action to take on output cuts (which was resolved only very recently) have contributed to an over-supply and storage space quickly filling up. Buyers and traders did not want to be left holding contracts for the physical delivery of oil that had nowhere to go. So they got rid of them as quickly as they could.
The negative price has largely puzzled the general public. Could producers really be offering to pay for the oil to be taken off their hands? In practice this is already happening in the physical market in the US for those who do not want to shut down their wells or who do not have their own storage space available. The New York Futures market trades financial contracts that are linked to the physical market.
When contracts near their expiry the holder would be stuck with the financial exposure relating to the physical delivery of the oil. Normally financial players close out their position before expiry to avoid this. In this case, when May contracts neared their expiry on Monday, it seems they couldn't probably because there was no available storage space and so no-one to take the other side of the trade. So for the first time, the WTI benchmark turned negative.
The negative pricing phenomenon could remain one that only affects American crude as long as there is an over-supply. WTI is only one of the three major grades used for global pricing. Brent Crude, which reflects pricing of output from the UK North Sea, and Dubai/Oman are still selling at a positive price – although the former has fallen nearly 70 per cent since the beginning of 2020.
North American producers, especially those in Texas and other landlocked regions, are particularly at risk, as they are impacted by the limits of domestic infrastructure and do not have a marine route for export. Conversely, Saudi Arabia, the world's largest exporter of oil, has quickly managed to store its surplus crude in Egypt and is still able to sell abroad.
But while negative prices will not necessarily apply to crude exports from the Gulf region or many of the major international oil companies, the broader downturn is affecting all industries worldwide.
Oil demand has understandably dropped significantly since the onset of the pandemic, and with uncertainty still surrounding the lifting of lockdowns around the world, the recovery may be equally drawn out.
This unprecedented ordeal is a reminder that multilateralism is essential not only when it comes to diplomacy, but also for a response to soothe markets in times of crises. There will be better days for the whole economy as well as oil demand once the pandemic subsides and we are free to go out again. But for the time being, the oil sector, especially in the US, is being buffeted by the unique circumstances of the pandemic. Energy exporters like the UAE have successfully navigated crises over the years, most recently the last price slump of 2015-2016 and emerged stronger amid an industry transformed by technology and new efficiencies. This time around the coronavirus may be prompting some landmark moments but those that were strong and competitive before it hit will no doubt bounce back in similar fashion.