After Negative Rates, Time To Brace For Negative Crude Oil

After Negative Rates, Time To Brace For Negative Crude Oil
After Negative Rates, Time To Brace For Negative Crude Oil
Deepika Asthana - 23 April 2020

It seems that developed economies are now fairly comfortable with negative interest rates. However, on April 20, the WTI (West Texas Intermediate) crude also turned negative. Is this the new normal? Or just an aberration. Let us put this in perspective.

WTI turns negative

WTI and Brent are the two benchmarks for crude oil prices. WTI generally trades at a discount to Brent. However, on April 20, the WTI plunged below -$37 per barrel. Think of it this way, oil producers are paying you money to buy crude. To be sure, this is not the first time a commodity has turned negative. Natural gas prices in the United States have achieved this feat before. Before we discuss the implications of negative crude oil prices, let us first discuss natural gas and the difference between WTI and Brent.

Difference between WTI and Brent

WTI is extracted from landlocked areas in the United States while Brent comes from oil fields in the North Sea. Since WTI is extracted from landlocked areas it is relatively tough to transport. Also, while the Brent contract is cash-settled, WTI is settled physically.

To understand why WTI prices turned negative, let us understand natural gas dynamics first. Shale oil fields produce natural gas as a byproduct. In normal times, companies earn money by selling gas. However, the natural gas market in the US is quite oversupplied. Also, if demand is weaker than expected, energy companies find it difficult to store gas. Natural gas prices have fallen into the negative on a few occasions as energy companies pay others to clear the glut.

What’s happening in crude oil markets

Crude oil prices have always been on a freefall this year. The OPEC block was slow to announce production cuts. Also, the production cuts are not enough as energy demand has tanked amid the novel coronavirus pandemic. Crude oil has to be stored and the world is quickly running out of storage space.

Amid storage issues, transportation challenges, and demand slump, not many want to take delivery of crude oil. This is the reason the current month WTI contract turned negative. The far month WTI and Brent crude contract too fell but are still positive.

Now, is this a new normal? No one would expect a rational business to sell a product for negative for long. However, WTI might face such a scenario amid the pandemic due to the way the contract is structured. For India, however, negative WTI does not help as the country’s crude oil basket is not based on WTI contracts but a blend of Brent (sweet) and Sour crude oil.

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