Oil prices have plummeted, hitting an all-time low

By MATTHEW BEDELL
On April 29, 2020

Photo courtesy of Mike Mozart, Flickr

Global oil prices have hit historic lows. They crashed hard last week, and for the first time ever, prices went negative. 

The first question to answer is how can oil go negative? Oil is a commodity and is therefore traded on the commodity market. Each month, contracts are created per physical barrel of oil that investors can trade back and forth. Oil contracts in the month of May during the last day of the contract are what went negative, according to WTI Crude. 

Buying these contracts can be rather risky, as the investor is expected to be able to take and store the amount of oil that they bought in contracts. Since this is the commodity market, the items being bought and sold are all physical and must be stored in someplace.

This is where the danger comes in. Many investors were lured by ludicrously low oil prices (around $25) versus two months ago (floating around $50) caused by the 2020 Russia-Saudi Arabia oil price war. Both nations kept production of oil high during the COVID-19 era that massively reduced the demand for the product.

The continued supply versus the lack of demand meant that oil prices were quickly dropping. Yet globally as this was happening, the existing storage capacity for oil was quickly being bought up and filled. Oil had a huge glut.

Investors who were buying the oil may not realize that they had to store the product that they were holding. They were speculating on oil prices and did not realize the risk attached to the contract.

The day the price of oil crashed was the day that the contract expired in May, meaning that the investors would be on the hook for storing and maintaining the oil. Many people holding the contracts tried to sell at once, and due to an already lack of supply of storage capacity for oil, caused prices to go negative.

The people who were holding onto the oil contracts literally had to pay other investors to take their contracts. At this point, they were holding onto a toxic asset, and they could not store the oil that they had bought.

Oil prices promptly shot up the next day for June's contracts, but prices as a whole remain lower than they were for May's contracts.

The second question: what does this mean for the consumer? It means nothing, for now. Gas stations are not going to give you money to take their gas. Gas is a finished product refined from oil, and the current oil has to be refined first before prices at the gas station start to dip.

However, in the long term, I do believe that we are going to see gas prices lower than $1.50 dollar per gallon. The lack of demand and glut of oil and gasoline is rapidly causing prices to drop nationwide.

In New Jersey, the current gas price average is $2, while the nation's average is $1.76. Slowly but surely, these prices are going to continue to decline until the economy restarts and demand resumes for gasoline.

 

mbedell@ramapo.edu

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