Crude Oil Price Below 0

Crude Oil Price Below $0! What does it mean for Indian economy?

Crude Oil Price Below 0
Crude Oil Price Below 0

One of key features of financial markets is price discovery of the asset class. So, when a buyer and seller agreed on a price of a liquid asset. Arguably then, the traded price should reflect all information about the asset class and its valuation by a market participant. Moreover, financial globalization has allowed market participants across world to efficiently discover price of an asset. For instance, Bond trader, supposedly sitting on his couch in Mumbai, can trade in US treasuries, thus his views are also reflected in the price of US bonds. But then again, this price discovery process has its own peril. More often than not, financial markets overestimates and stretch prices in either direction!

Why crude (WTI) traded below $0? What does it reflect?

Over the last few years, crude oil prices have been trading with bearish bias amid huge demand-supply mismatch. Oil demand has remained tepid owing to slowing global economic activity. On other hand, US Shell gas production and weak-coordination between OPEC countries have kept supply in abundance. In recent months, Russia and UAE had failed to reach a deal leading to fall of OPEC agreement, this has led to a free fall in crude oil prices from $45 per barrel to below $20 per barrel. Crude oil price below $20 has a lot of macro-economic interpretation – very low economic activity, fear of recession, abundance of supply, rising oil inventory……..! On 20th April, something unique happened, May month future of West Texas intermediate (WTI) crude had slipped below $0 and even traded -$39 per barrel.  This blog like to argue that although, WTI below $0 is an historic event, but it does not give much additional information to macro-economist to digest.

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WTI crude future is basic commodity derivative contracts, wherein, a buyer of contract has an obligation to buy 1-barrel WTI crude price at pre-agreed price and on expiry date. WTI future derivative has a condition of physical delivery rather than net settlement. (A net settlement is an exchange of gain or loss on date of expiry). In case of physical delivery, the buyer needs to store large quantity of WTI crude, thus making storage of crude a very critical factor. As Morgan Stanley’s report explains that Cushing, Oklahoma (pricing point of WTI) storage capacity is likely to be full by May, when contracts maturing on April 20th will be delivered. Thus, lack of storage capacity created huge selling pressure in first month future contracts as market participants just can-not afford to take delivery of oil. Hence, they start offloading their long position lead to sharp fall in WTI future prices to negative $39 per barrel

As depicted in figure above, there has been a significant decline in daily volumes due to Covid-19 outbreak. In fact, the free fall in future prices were further accentuated by nearly 86% lower volume on 20th April against average volumes.

Aug-2020 WTI crude future is trading $21.50 per barrel and May-2021 WTI crude future is trading at $30.50 per barrel. Brent current month future, which are listed at ICE Europe, is trading at $20 per barrel. Thus, it is safe to say that price action below $0 is not a true representation of crude price in general.

What does it mean for Indian economy?

Owing to geographical constraints India procures its crude oil from middle east and Brent crude. We do not import WTI crude from US. So, we can not buy crude for free, having said this broader lower trend in crude oil prices should be beneficial for us. Lower crude price should improve current account and allows government to increase excise duty. It is noteworthy every 1 rupee per barrel increase in exercise duty yield in nearly INR 14,300 Cr additional revenue in a year for government.  

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At last, global crude oil prices likely to remain under-pressure amid huge slump in economic activity due to Covid-19 pandemic. For India, lower crude oil prices may be only positive macro-economic factor amid Covid-19 outbreak.

Refrences: Negative Oil Prices – What Is Going On? – Morgan Stanley!

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