Free Fall, Oil Prices Go Negative

[David Hayden]

I wondered how prices coud go negative and looked into it. I believe it works like this:

Some time ago, let's say January, someone buys a "futures contract" to take delivery of a tanker full of oil on May 1st.

Lots of other people do the same thing, and they buy and sell these contracts as Wall Street traders do. None of these traders intends to actually take delivery of the oil, they just hope to buy low and sell high.

The key here is that they intend to sell. Indeed they must sell because they have nowhere to put a frickin' tanker full of oil in their Manhattan apartments.

Meanwhile in Saudi Arabia, ARAMCO fills a tanker with oil and starts it heading to the USA. That contract is valid so they have to deliver that oil.

But where to deliver? The tanker captain has to know ahead of time. So the contract to take delivery of oil on May 1 actually "expires" (or some phrase like that) on April 20. At that point, whoever holds the contact can't sell it and they have to tell the captain where the oil should be delivered.

So back in January, lots of people bought contracts for lots of oil to be delivered on May 1. Then COVID-19 happened, the demand for oil decreased and nobody wanted to take delivery. So as April 20 got closer and closer, the price of those contracts went down and down until finally, the poor slobs holding the contracts were paying people to take them. Again, the ones who held the contracts had nowhere to put the oil so they had to get rid of the contract and ended up paying people to take it.

This is how the price drops below zero and why the Saudi's didn't just stop pumping the oil. Presumably they will decrease production, but hey, a contract is a contract.

Dave