Oil: market mechanisms explain the collapse of oil prices

  •   22/04/2020 - 17h15
  •   DEHOUI Lionel

The collapse of oil prices observed in the market is the result of several market mechanisms, most notably ETFs, exchange traded funds. The price of a barrel of U.S. crude oil, West Texas Intermediate (WTI) for a contract expiring next month, fell to below $40. A situation that investors have never experienced in the oil market. It has been worsened by falling economic indicators, but also by the inadequacy of storage infrastructure in the United States. The crude oil contract for next month expired Monday, meaning buyers must receive delivery of their goods. To this end, oil buyers have declined to receive delivery due to the lack of availability of storage facilities. Unable to store the oil, the purchasers made a compensation payment for a cancellation of the purchase contract. This led to the price being negative for the first time on the market.

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Oil: market mechanisms explain the collapse of oil prices
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The sale of contracts

Stéphane Déo, one of the management company's strategists, explains in a publication that: " Tous stakeholders had to resell their May 2020 contracts, whatever the price, even négatif ". This situation went quickly due to the evolution of ETFs compared to WTI. The storage and receipt of oil is not a function of listed index funds, ETFs. The latter just ensured the liquidation of a barrel of oil on the market at any price.

 

The fall in demand

If the market registers a 90% rise on Tuesday, the price of West Texas Intermediate (the market reference in America) could experience a negative of less than $3.91. On the other hand, in Europe, Brent is subject to a loss of more than 18% to reach a value below 21 dollars per barrel. It should be remembered that at the beginning of March, the price of a barrel of oil fell by 25% due to a conflict between Saudi Arabia and Russia.

The conflict between Saudi Arabia and Russia last March arose against a backdrop of falling global demand for oil. The fall came from China, which is the world's largest importer of oil because of the impact of the Covid-19 health crisis. Decisions to reduce global oil production will not alleviate the crisis. This is due to falling demand and strong inventory growth in the coming months.

 

Further information

From 1 May onwards, a rise in oil prices per barrel will only be evident through a considerable drop in production, but also a normal recovery in demand. This will only be possible after the lifting of the containment measures. Lower oil prices will have enormous consequences for the energy sector and for the US debt sector.