the economy

How Oil Prices Can Go Negative

Photo: Yegor Aleyev/TASS

The mass closure of restaurants has led to a national oversupply of green beans. Americans apparently don’t eat as many fresh green vegetables when they eat at home. And even if people do want more green beans to cook at home, producers also have difficulty switching on a dime from serving the commercial market to serving the retail market. But at least farmers with too many green beans don’t have to pay someone to take their excess green beans. They don’t even have to pay someone to pick the green beans. They can just plow them back into the soil, plant again, and hope somebody will want to buy green beans in a few months. For this reason, the price of green beans cannot go below $0.

But what do you do if nobody wants the crude oil that comes out of your oil well? You can’t just dump it on the ground or pour it in a river or burn it; the EPA wouldn’t take kindly to that. You also generally can’t just turn the well off if you want the option to get oil from it in the future; oil wells are expensive to drill and you think prices will be positive again in the future, so you don’t want to lose the well. But in the meantime, oil is going to keep coming out of the well and you are going to have to get someone to take it off your hands, even if that means paying someone to do it. That’s why the price of crude oil can go below $0, at least for some period of time.

On Monday, the price of West Texas Intermediate oil futures for delivery in May fell to -$37 per barrel. You should not read too much into this as an indicator of ongoing prices for crude oil, let alone gasoline. Tuesday is the last day to trade the WTI futures contract for oil to be delivered in May, and if you get stuck holding an oil futures contract after trading in it ends, you may be obligated to actually take delivery of actual crude oil — so investors who aren’t actually in refining or other oil-consuming fields have to get rid of their contracts, and that has led to some screwy activity in a market with thin trading. The futures contract for June, trading around $17 per barrel as of 6:45am Tuesday, may be a better indication of the sort of crude oil prices we can expect to see in the next few weeks — positive, but far below pre-crisis levels. The June futures contract had been trading above $50 a barrel as recently as February 26.

You might be wondering: If crude oil is essentially free right now and expected to still be very cheap in June, why am I still paying $2 per gallon for gasoline? There are a couple of answers to this. One is that you can’t put crude oil in your gas tank. You need a refiner to make gasoline from the crude oil, and oil refiners have cut their production. Some refineries have closed entirely. (This disconnect — refiners shrinking production while extractors continue to produce — is why charges for oil storage have skyrocketed and market participants are worried about running out of places to put crude oil.) The other factor has to do with the operations of gas stations. They are able to buy gasoline much more cheaply at wholesale than they could a couple of months ago, but they are also selling much less volume of gasoline. As such, they need a higher markup per gallon to cover their non-fuel costs than they used to, and average retail gasoline prices are only down 97 cents per gallon from a year earlier, even with wholesale prices down $1.51.

Normally, falling crude oil prices provide benefits to consumers that go a long way to offset the economic costs from lower income to oil company owners and workers. But it’s not obvious when and how much you will get to enjoy any benefit from this price crash. You’re not driving much now. And in the medium term, oil producers will cut back on production. When the economy gets going again, they will be slow to start production back up, in the same way they are slow to shut it down right now. Market participants expect oil prices next year to be over $30 a barrel — which means as the economy restarts, you should be able to enjoy lower gas prices than you saw in 2019. When gas stations have a normal volume of customers, they will face more pressure to pass fuel cost cuts onto them. But if and when the economy gets back to roaring, the bust for oil producers in the current crash should lead to a more constrained supply. That could push prices up.

How Oil Prices Can Go Negative