What just happened to the crude oil price? – Investometry

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You must have heard that the crude oil prices has crashed to zero and now it is trading in negative prices. The last time I saw the price was around negative $40. Does that mean that if you buy crude oil then you will get $40 for that? What drove the price to fall to zero and then negative? Let’s find out.

What is Crude oil?

  • Crude oil is the raw natural resource that is extracted from the earth and refined into products such as gasoline, jet fuel, and other petroleum products.
  • Crude oil is a global commodity that trades in markets around the world, both as spot oil and via derivatives contracts.
  • Crude oil is used in many Industries. The petrol or Diesel we use is a derivative of crude oil which means that is extracted from crude oil. It is also used in chemical industries, aviation industry, automobile industry, etc.
  • The price of crude oil was $60 per barrel and 1 barrel consists of 159 Litres.

Impact of Lockdown

The price of every thing depends upon the demand and supply. Due to the spread of Covid_19, many nations had no option but lockdown. Almost all the companies stopped their business due to the spread of virus, Production had came to almost zero, global market crashed and liquidity problems also came up. The shops, offices, restaurants, etc were also closed globally. Thus due to the lockdown demand of the products fell. Travelling is also restricted and people has to stay in their home till the lockdown gets lifted so the fuel consumption also dropped drastically.

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Since fuel is a derivative of crude oil and fuel is widely used across the globe, the drop in demand of fuel lead to drop in demand of crude oil along with the drop in demand in chemical and aviation sector.

Demand also dropped in the past.

Yes that’s true that demand of crude oil has also dropped in the past several times but the producers used to lower the supply at that time to maintain a steady price. So why they didn’t lower the demand now?

Crude oil production needs a huge capital due to the use of heavy machineries and once the production is stopped, it will cost a huge amount of money to again resume the production. Oil production can be lowered upto a limit and due to the lockdown the demand fell drastically. Many countries depends upon oil production so none of them will be willing to lower or stop the production which will keep the supply as it was. So there is a option of storing the oil which was produced. Storing of oil will help but to an extent. The producers has been storing oil now the storages have got full as there was a minimum use of oil with a high amount of supply.

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Price of oil went to negative?

The ans is no, the price is still around $15 to $20 per barrel. The forward contract price went to negative. In case you don’t know what is froward contract then let me tell you that it is an agreement between two parties to buy or sell an asset at a specified price on a future date.

For example, if I have a deal with you that I will sell one barrel of oil to you at a price of $70 on 25th April. You thought that the price will go up and you could buy the barrel at $70 and I thought the price will go down so i will make a profit by selling at $70. I told you that after that date if you sell it to someone else I will deliver it to that person and if you kept it with yourself i will deliver it to you. Eventually the priced dropped to $20 and you couldn’t sell it to anyone. So you will have to keep the barrel but you don’t have the licence to keep it and if you keep it at your home or anywhere then you have to pay a fine let’s say about $300. Now you got into a trouble as no one is buying even if you give them for free. If you keep it then you already suffered a loss of $50 ($70-$20) plus the fine of $300. So you decided to sell it to a person for free and you will give $50 extra to that person. This way the price of forward contract went to -$50 per barrel.

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This was just an example to make you understand the concept.

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21 | Small & Mid Cap Investor | CFA L1 candidate | Blogger | Reader | Engineer | Life-Long Learner
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