The Peak Oil Doom: Explained

Public Policy Club BITS Pilani
6 min readApr 29, 2020

On 20th April 2020, the price of one of American futures contracts dropped below zero for the first time and then they just kept falling. By late afternoon, the futures for May were selling at minus $38.7/barrel. As the global demand for oil has gone down from 100 million barrels to 29 million barrels in just one year, and the storage space filling up fast, companies are ready to pay to get the crude oil off their hands.

May Futures? But isn’t it April going on. Ugh! Is it May already? Locked inside, I can’t even tell the difference.

No, don’t worry it’s still April going on. May futures, as the name suggests, talks about a transaction in the future. It’s a legal agreement that gives you the right and obligation, to buy or sell an asset at a predetermined price on a predetermined date usually around a month’s end. For example, if the agreement was for me to buy at say $10 and the current market price is $12, then the difference of $2 is my profit. However, if the current price goes down to $7, then the difference of $3 becomes my loss.

Okay, that's fine. Then why are we even bothered about May?

Tuesday is the last trading day for the May futures of Crude Oil, which means the traders who own the May futures will be receiving barrels of stinking oil. Imagine a game of Passing the Parcel, no one wants to be holding the parcel when the music stops. The factories that need crude oil are simply not operating amid the lockdowns, work-from-home means that lesser oil is being guzzled by cars. Thus the simple rule of supply-demand kicked in, low demand, and high supply means that the prices will go down. Just, in this case, they went down well into the negatives.

“However, this is more of a technical clash rather than a real-world clash. The prices of May and June futures differ by $60, the highest price difference between two back-to-back futures ever seen”Bloomberg reported. Most of the actual trading is going on in terms of the June futures since the traders are still optimistic that the situation will improve in a month.

So why is the price of just one future, that too of only one firm, going into negatives such a big deal?

Had it been just any firm, it wouldn’t have caused so much noise. However, the firm that is being talked about here is West Texas Intermediate (WTI), that’s why it is important. When one talks about oil prices, it is usually done in terms of benchmarks, WTI is the benchmark for the US, just the way Brent is the benchmark globally. There are different kinds of oil differentiated by their density and sulfur content. Both WTI and Brent are light and sweet which means that these going into negatives is highly unlikely.

Then why did only WTI’s prices go negative and not Brent’s?

While WTI’s May futures were trading in negatives, Brent Crude’s May futures were still well above zero. This large divergence was due to one major factor.

Brent contracts are settled in cash, while WTI contracts are settled in physical barrels. So it makes sense that someone will pay you to take the stinking oil away, but no one will pay you to take the cash away.

Last Monday, someone at WTI who didn’t want the actual delivery of oil, which was most of the traders, could either reverse out, which means sell their contract to someone else or rollover, i.e. close the current contract by buying one for the future.

Since the WTI barrels were trading at minus $40, it meant that someone rolling over would lose around $60, $20 from the initial May price and $40 from the negative cost (Yes, this is the logic behind the Bloomberg report of the price difference of $60 between the May and June futures).

Does this mean that I’ll be paid to fill up at the petrol pump? Where are my car keys?! Petrol pumps, here I come!!

Even though crude oil and petrol prices are linked they don’t necessarily reflect each other. So getting paid at the petrol pump is highly unlikely due to several factors. First, there is a lot of money that goes into transportation, marketing, and refining of the petrol that we get at the petrol pumps. Then there are taxes levied on the oil, which further increases the cost. Also, there is no guarantee that the retailers will pass on the benefit, chances are that they’ll increase their profit margins to make up for the decrease in demand. So, unfortunately, you can get the entire barrel of oil and be paid for that, you still have to pay at the petrol pumps.

So why don’t people just stock up on oil? I mean if they can do it for toilet paper, why not buy now and sell it off later and earn money?

Yes, this is the best time to go crude shopping, everything is on sale. However, there is simply no space in the closet. India, the third-largest consumer of oil worldwide, has only storage space of 39 million barrels. This is much lesser than other Asian countries such as China(550MB), Japan(520Mb) and South Korea(214MB).

Why is it so bad for the economy? The prices go up and down all the time.

When a company cuts back on its oil production, it is done majorly in two ways, First by halting the drilling of newer and uncompleted wells. Second by an extremely painful process called ”shut-ins”, i.e turning the tap off in the existing wells. However, an oil tap is not like the household water tap. You can’t just turn it off and then turn it back on. There is no guarantee that the taps once turned off can be turned on the same capacity again. Some have argued that it’ll cause damage to these taps which will cost time and money.

Also, some companies might not even be around to turn them back on. A lot of oil companies will be filing for bankruptcy if the prices don’t shoot back up soon enough.

Whiting Petroleum Corporation has already filed for bankruptcy.

So when the demands do come back, there simply won’t be enough supply.

And even those companies who do survive, won’t be keen to turn the supply back to their maximum, because they’d want to be sure that there is no second wave of the ongoing pandemic.

So if this thing was so simple and obvious why didn’t anyone think of cutting down on production before the oil prices went into a negative? Duh!

Heard about the Russia-Saudi Arabia Oil Price War? Well, blame it.

In summary, OPEC asked everyone to cut production, Russia didn’t possibly because it was angry at the US, so Saudi Arabia decided to throw an expensive “why-only-me” tantrum.

Wait, what? Slow down and rewind a bit, please.

n 2014, the US upped its shale oil production, however, there was no reduction in the production by others. Bringing in the Supply-demand, the prices crashed from $114 in 2014 to $27 in 2016. To control this, in September 2016, Saudi Arabia and Russia decided to cooperate and control oil prices. They formed OPEC+ consisting of OPEC (Organization of Petroleum Exporting Countries) and non-OPEC countries and have reduced the global oil production by 2.1 million barrels per day. In a summit on 6th March 2020, in Vienna, it was decided to cut the production of oil by 1.5 million barrels per day in the second quarter of the year.

However, Russia refused to cooperate, thus ending the unofficial alliance. This may be Russia’s way of retaliating against the sanctions imposed by the Trump Government on Rosneft, the largest Russian oil company.

So even though the negative May futures of Monday are in reality “more of a financial thing than an oil situation” as said by Donald Trump, the “oil situation” isn’t great either.

— written by Manasvi Singh.

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Public Policy Club BITS Pilani

Public Policy Club is a student-body based in BITS Pilani which reviews policies and inscribes the reports for elating political acumen among the readers.