COVID TurmOIL - Big Blow to Crude Markets Explained

For a brief period on 20th April 2020, West Texas Intermediate (WTI), a grade of crude oil used as a benchmark in oil pricing, plummeted to NEGATIVE $38 a barrel. Yes, a barrel of oil was cheaper than a Starbucks coffee. Oil producers ran out of space to store the oversupply of crude left by the corona virus crisis, triggering this historic market collapse which left oil traders reeling.

It means that if you were to "buy" a WTI May Futures contract (an order for a thousand barrels of oil, delivered to a specific location on a pre-decided future date), you would be "paid" $38,000. A WTI Futures contract mandates that whoever buys the contract has to collect the barrels of crude from Cushing, Oklahoma, the United States, where energy companies store their oil in a facility that has a storage capacity of roughly 75 million barrels.

Why had this nosedive in oil prices not prompted people, firms and governments alike to rush and "buy" this precious commodity? Well, the situation was a little more complex than that. Before we explain why negative oil prices are not necessarily a good thing, let us first dive into the intricate world of this valuable commodity they call black gold.

What causes the crude prices to fluctuate?

Just like any other commodity, oil prices are also driven by the market forces of demand and supply, as shown in the above figure. However, the law of demand holds in case of ceteris paribus, that is, with everything remaining constant. In fact, since the last three months, nothing seems to have been constant. The current global pandemic has a huge role to play in defying the law of demand shown above.

With a general decrease in demand following global lockdowns and ban on travel, the demand for oil went down automatically. This, combined with an oversupply of the commodity led to a steep fall of crude prices for a brief period, in the month of April.

Apart from the exogenous factors of demand and supply, the global oil prices are sensitive particularly to the clout of the Organization of Petroleum Exporting Countries (OPEC+).

OPEC+ which produces 40% of the world’s crude oil, is a cartel that is a group of 14 of the worlds major oil-exporting nations shown in the above picture.

Now that you understand why the prices of unrefined oil oscillate, let us look at the two most popularly traded grades of oil being WTI and Brent Crude.

Brent vs WTI