Oil Below $0 A Barrel??

How does that work? Can I get paid for taking a barrel of oil? No. Oil *futures* are below $0. A couple guys on reddit explained it very nicely yesterday.

AdmiralAkbar (It’s a trap!) described it this way:

For those unaware, futures contracts are essentially pre-ordering something, hoping it sells out, and then scalping it on eBay, but on a far larger scale. You have a contract agreeing that you’ll buy something at a certain price (the settlement price) at a certain date (the settlement date). Let’s say that you make orange juice, and I want to buy orange juice. I offer to pay you $3 for a gallon of orange juice that I’ll pick up next Saturday. When Saturday comes by and I pick up the orange juice, if the price goes up to $5 a gallon, you still have to honor our contract and give it to me. I then can sell it for a $2 profit. If the price had gone down to $2 a gallon, I’d be left with a $1 loss.

(If you’ve seen Trading Places and understand what the bad guys’ scheme was, feel free to skip this part.)

If you’ve seen Trading Places, the bad guys do most of their trading in commodity futures contracts. Their plan is to corner the market (i.e., hoarding enough of a good to the point where they can sell it for however much they please) in orange juice futures. They steal a US Department of Agriculture report about that year’s orange crops, thus allowing them to plan their strategy before everyone else knows. However, Dan Akroyd & Eddie Murphy give them a fake report saying that it was a bad harvest; this makes the bad guys think that the price will go up, so they plan to buy up a bunch of futures before the report is announced. If the price goes up as they hoped, they’ll be guaranteed to have the lion’s share of the country’s orange juice for cheap. So at the start of the trading day, they submit an order that says “use everything we’ve got to buy as many orange juice futures as possible.” A bunch of other people go “They’re buying orange juice futures, they must know something I don’t” and start buying orange juice futures too. This spike in demand causes the price of futures to go up; the bad guys don’t mind, because they know they’ll still make shitloads of money from it.

However, the actual USDA report is that the harvest was normal, and everyone starts panicking; they can’t undo the sales, so they’re stuck with futures they paid more for than it’s actually worth. Everyone wants to sell, and the collapsing demand drives the price down. However, Akroyd & Murphy spent the entire morning short-selling orange juice futures.* So now in order to fulfill their short sales, they start buying everyone’s orange juice futures for cheap… except for the bad guys. At the end of the day, the bad guys are on the hook for hundreds of millions of dollars while Akroyd & Murphy become insanely wealthy from their trading.

**Short-selling is essentially the inverse of regular trading. In regular trading, you borrow someone else’s money, buy a stock/bond/future/etc. when it’s low, sell it when it’s high, pay back the loaned money, and pocket the difference. To make a profit, you hope that the asset goes up in value. In short-selling, you borrow someone else’s stock, sell it when it’s high, buy it when it’s low, pay back the loaned stock, and pocket the difference. To make a profit, you hope that the asset goes down in value.*

What’s happening now is what happened in Trading Places when the real report comes out: people realized that they overpaid for their futures and are selling to try and recoup some of their losses. There’s barely any demand for oil right now, there’s little hope that there’ll be more demand for oil in May, and there’s very little storage space left already. Low demand + high supply = low prices. A few days ago, the settlement price for a barrel of oil for futures contracts with May settlement dates was locked at ~$18 a barrel. People expect it to be way lower than $18 next month. So, what they’re doing is trying to sell off their futures contracts. It’s going negative because they’re literally paying you to take it off their hands if you have room for it. Although they know it’ll be a loss, they figure it’s less of a loss than holding onto a bunch of worthless oil that they can’t store.

A very succinct and, imo, brilliant explanation. So what does that mean for the average person? Again, reddit delivers, this time user kinyutaka, who answers the question: “What’s going on with the economy? What does the price of oil dipping below $0 per barrel mean for the average person?

kinyutaka explains:

Answer: The oil prices are set up using futures contracts, selling or buying a promise to deliver 1000 barrels of crude oil on a certain date.

These contracts are sold by the oil rigs and/or oil depositories and are bought by oil depositories or refineries or manufacturers.

They can also be bought and sold by speculative investors.

This has worked out just fine for decades, because there has been a near constant demand for oil. It goes up or down, but it’s always there.

Tomorrow, the May contracts for crude oil are expiring, so people who own the contract will have to collect 1000 barrels per contract, but speculative buyers have nowhere to hold the oil, and depositories are full, and aren’t buying contracts for May anymore.

This creates a panic selling situation, and the price tanks.

Because you have to collect the oil, there are regulatory concerns for people holding onto the contract. They can’t do anything with the oil, and can’t sell the contract for any price. That means they have to pay someone to take the worthless contract off their hands.

This will have effects in the gas prices. Cheaper oil means cheaper gas. And this will affect related oil stocks, like Chevron or Texaco, but these effects will largely be temporary, as the June contracts, while down, are still in positive territory.

This will not generally affect people’s day to day lives at all, unless you work for an oil field that is not considering shutting down.

So basically: the oil prices that everyone is screaming about is driven in large part by speculators who are now losing money due to cultural behavioral events related to coronavirus.

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