Negative oil prices on Monday were a “quirk”, says one market expert.
The price of US oil – which slumped to minus $37 at one point – was produced by a trading deadline and is now back close to a positive figure.
The UK oil price has been hit too, but the price of a barrel of Brent crude is now at about $23.
“Yesterday’s price action is best understood as a quirk or peculiarity of futures trading,” said analyst James Trafford of Fidelity International.
He reckons the unprecedented price movement confirms that near-term demand is very weak.
“But it isn’t cataclysmic,” he said. “We don’t see negative oil prices as a new normal, going forward.”
Oil prices have weakened sharply because of a combination of oversupply and a collapse in global demand due to the decline in economic activity cased by coronavirus lockdown measures.
What happened?
The price of oil that we see reported is actually the future price of oil. Futures are essentially contracts to deliver the physical commodity at a later date.
So when we look at oil prices, we are actually seeing the market price for future months.
As the delivery date approaches, these contracts need to be rolled over to the subsequent period.
The price of a barrel of West Texas Intermediate (WTI), the benchmark for US oil, fell into negative territory for the first time in history on Monday.
But that only related to the May contract, which was about to expire.
Traders holding the contract were unable to find buyers, because no one with the ability to take delivery wanted it.
“Nobody wants to take delivery of oil next month because there’s nowhere to store it, so the price dropped below zero,” explained Rachel Winter, associate investment director at Killik & Co.
Storage issues
The collapse in physical demand for crude products like petrol and jet fuel has left storage hubs at capacity or, as one trader put it: “They’re close to the brim.”
Storage at US oil hub Cushing has already grown to more than 15 million barrels in the past month – and is expected to soon be at capacity for the first time ever.
“Coronavirus is rewriting the rules of the global economy in front of our very eyes,” said Adam Vettese, analyst at eToro.
“With oil demand virtually non-existent, this quite amazing sell-off is almost entirely down to fears over storage.”
Paying for extra storage for all that unwanted oil means extra costs for producers and traders.
“Storage constraints are not going away any time soon unless you get a pick-up in demand,” pointed out Neil Wilson of Markets.com.
Does that mean oil prices will fall further?
“Oil prices and associated equities in the sector will remain broadly weak over the near term,” predicted James Trafford.
He said the supply cuts recently agreed by the Opec group of oil-producing economies were not likely to be sufficient to balance the market any time soon.
Opec is believed to be looking to cut oil output immediately, rather than waiting until next month, to ease the pressure on price.
“The kind of dislocation witnessed on Monday, however much some may downplay it, points to a fundamental problem in oil markets, namely a lack of storage capacity and demand,” said Neil Wilson, senior market analyst at Markets.com.
“But it also shows the market trying to do its job, forcing the price down enough to shut production.”
Artur Baluszynski, head of research at Henderson Rowe, agreed that the effect was temporary, but warned of its implications.
“While Monday’s negative WTI futures price might have been a one-off glitch, it does confirm there is trouble ahead,” he said.
“The Covid-19 crisis is destroying the global demand for energy and without a timeline on the end of the lockdown in the developed world, the market is suffering from chronic oversupply.”
Will the price of petrol fall?
While the price of petrol is linked to the wholesale price of oil, it is driven by competition.
That means that what motorists pay is not directly linked to crude. Instead, suppliers control the prices they sell petrol at.
So you won’t see the wild fluctuation in pump prices that we’ve seen in oil in recent weeks.
Crucially, a key factor affecting the price of fuel is that the biggest proportion of the money you hand over for a litre of petrol in the UK goes to the government in the form of tax.
Fuel duty is charged at 57.95p per litre. On top of that, you have to pay VAT at 20% on the cost of petrol.
So there’s little scope for further reducing the pump price of petrol.
Below £1 a litre?
Competition has driven the price of petrol down close to £1 in recent weeks at some supermarkets, where prices tend to be lowest.
Could this week’s oil price turmoil see prices drift below £1 for the first time since the late 2000s?
“In theory, petrol prices could fall below £1 per litre if the lower wholesale costs were reflected at the pumps – but at the same time, people are driving very few miles, so they’re selling vastly lower quantities of petrol and diesel at the moment,” pointed out RAC fuel spokesman Simon Williams.
This means many forecourts will be reluctant to trim their prices any further, he said.
At the same time, more price pressure on petrol could hit the viability of independent garages, he warned.
“We continue to be concerned about smaller forecourts that provide a vital service in areas where the supermarkets don’t have a foothold, as many are already finding conditions tough with sales having fallen off a cliff since lockdown.
“It would be bad news all round if these forecourts shut up shop for good.”
Are pump prices fair?
Since the end of March, the wholesale price of petrol has been around the 16p a litre mark, according to the AA.
“Add fuel duty at 57.95p a litre, a generous 9p a litre supplier/retailer margin, plus VAT and the average pump price of petrol would normally be around £1 a litre,” said the AA’s fuel spokesperson Luke Bosdet.
Instead the average pump price is higher because the retailers say they need to charge 10p a litre more to offset the lower volumes of fuel they are selling, he pointed out.
Journey levels are at around 40% of the normal during the working week, falling to 20% by Sunday.
“That means that some drivers, such as NHS and other essential workers, are using their cars and being overcharged on average by more than a fiver a tank,” Mr Bosdet said.
“I suspect that when the lockdown comes to an end, coronavirus is beaten and driving starts to return to normal, questions will be asked about the fairness of pump prices during the great oil crash of 2020.”
Source: BBC
