Oil prices went negative this week. What does this mean for us?

On Monday evening, the value of a barrel of West Texas Intermediate (WTI) oil, or Texas Light Sweet, declined to an unprecedented MINUS $40.32. It was the blackest of days for black gold.

Since the wildcat Colonel Edwin Drake successfully managed to drill oil out of the ground in Titusville, Pennsylvania in 1859, thereby creating the modern petroleum industry, oil firms have swung financially between great highs and terrible lows.

But though it has experienced gluts and shortages, the price of oil has never been negative, until this week. So how did this happen and what does it mean for us?

Why did the price of oil fall so far?  

Since the coronavirus has ravaged its way across the world, governments have introduced severe restrictions on travel, work and business.

Consequently, fewer people are getting in their cars, flying abroad. Fewer business owners are heating their office spaces. All these activities rely heavily on oil, so as their use has drastically diminished, so has oil demand.

Oil companies would typically respond to lower demand by pumping out less of their product. However, they have kept the taps running, which has lead to a massive oversupply of oil.

But the dwindling value is also partly to do with how oil is traded.

In the ‘futures’ where all is not well 

Unlike many stocks and shares, oil is traded on its ‘future’ price.

An oil futures contract is essentially a legal agreement among two parties to trade a specific amount of oil at a predetermined price on a particular date. When that date arrives, traders have to pick up the oil and store it.

Oil traders can also buy futures well in advance of the delivery date in the hopes the price will rise, and they can flog it for a profit before the date arrives. 

But Covid-19 has caused the oil price to worsen. And as production remains high, the amount of storage space started to run dry.

This problem was particularly acute at a crucial storage hub for Texas Light Sweet in Cushing, Oklahoma, which is nicknamed the ‘pipeline crossroads of the world.’

So when the deadline for Tuesday’s May futures contract on the oil was approaching, traders panicked and rushed to jettison their contracts. This led to tempestuous moves in the price, and all of a sudden, the WTI price fell into negative territory. 

What does this mean for the global economy?

Most of the world, including the UK, follows the Brent Crude benchmark, so the fall in the WTI price would not have such a critical impact on the UK economy.

However Brent Crude has also slumped to a two-decade nadir this week, which could seriously hurt domestic oil producers.

The UK is not a major oil-exporting nation, however. So, when oil prices are depressed, large oil-exporters such as Saudi Arabia usually suffer. Nigeria, Venezuela, Iran and Iraq are all taking an especially huge gut-punch from the crisis.

Notably, all these countries were already struggling economically before the coronavirus hit because of years of weakened oil prices. They also had other grievous issues.

Nigeria was experiencing an energy supply crisis and fighting Boko Haram; Iran was under the boot of US sanctions; Venezuela was in a depression, and Iraq was dealing with ISIS, religious sectarianism, and mass protests to name just three.

New threats of political instability in these countries have arisen because of the acute contractions in the oil market. If they are not adequately resolved, then the knock-on effect will be devastating politically and economically.

What does this mean for the petroleum industry?

It costs a lot of money to get oil out of the ground and so it has to be sold above its ‘breakeven point’ to make a profit. So if the value is below that line, producers will tend to be hurt,

Imperial College, London’s Professor of Sustainable Energy Business Richard Green, points out that the shock negative price was ‘just for oil needing immediate delivery and that prices further out are still positive.’

Indeed, WTI prices shot back up into positive figures the following day, although they were still extremely low. Yet we could very well see hundreds of American oil companies going bankrupt though.

Rystad Energy estimates that over 500 oil companies will file for bankruptcy by the end of 2021 if US oil trades at $20 a barrel, while at $10, the number of bankruptcies would double.

British oil firms are not immune from the shock either, though they are less affected, because they tend to rely on the Brent Crude benchmark. 

Ross Dornan, a market intelligence manager for the trade body Oil and Gas UK, says that the ‘triple whammy’ of cheap oil prices, low gas prices and Covid-19 could create serious supply chain issues for the industry in the short and medium-term.

Will our cars cost less to fill up at the petrol station? 

One of the many images that conveyed the 1973-74 oil embargo in the USA are the long queues at ‘gas stations’ of motorists waiting to fill up their Cadillacs and Fords.

The current oil crisis may look the exact opposite, with too few people going to the petrol station, even though the cost of petrol will have been markedly reduced.

Travel has already been severely curtailed all over the world as a result of government-imposed lockdowns. The motorways are quieter. Birdsong can be heard on the streets of London. Perambulating is the new norm.

Common sense might dictate that petrol prices should drop until the customers return. But we are not in normal times. As the AA’s fuel prices spokesman Luke Bodset notes:

‘In normal times, the collapse of the oil and wholesale price would have taken that average to £1 a litre. 

‘However, the petrol retailers say they need to charge that extra fiver a tank to offset lower sales volumes. It is likely that there will be a call for an official review of this once the lockdown is over.’ 

Could there be a rush – or delay – to renewables?

Countries were already starting to make the great transition from the fossil fuel to the solar panel and the electric car before the coronavirus hit. Prices of these goods were beginning to become seriously competitive with carbon-heavy energy sources.

The considerable drop in oil prices could put that move back some years. Lower oil prices, as Alex Kazaglis, a director at business management consultancy Vivid Economics points out, have generally made green energy less competitive.

However, there are three reasons he gives as to why this time could be very different. For oil exporters such as Saudi Arabia, the bargain-basement price means there is a greater economic incentive to invest in renewables.

Were exporters to accelerate their spending on renewables, investors could then interpret this move as a sign that oil margins will be low, and so put more of their capital into green resources.

Lastly, for oil importers, he observes: ‘Renewables are cheap enough that a credible plan for building back better and producing energy domestically could be the preferred path. So the impact may be more neutral than in past experience.’

Nonetheless, petroleum will continue to remain a significant part of our lives for some time, because so many people’s cars rely on petrol, however much the Greta Thunbergs of the world may despair. 

Oil may be the footballer that will never win another World Cup, but he has plenty left in the tank to win the Premier League one more time before he hangs up his boots.