The coronavirus pandemic has caused a series of mind-bending distortions across world financial markets, but Monday featured the most bizarre one yet: The benchmark price for crude oil in the United States fell to negative $37.63.
That means that if you happened to be in a position to take delivery of 1,000 barrels of oil in Cushing, Oklahoma, in May — the quantity quoted in the relevant futures contract — you could have been paid a cool $37,630 to do so. (That is about five tanker trucks’ worth, so any joke about storing the oil in your basement will have to remain just that.)
There are two ways of looking at this. First is what happened in a technical sense. The collapse of the May futures contract for West Texas Intermediate crude oil shows how the shock of the crisis is rippling through all sorts of markets and making them behave strangely.
But the broader takeaway is that the COVID-19 crisis is an extraordinary deflationary shock to the economy, causing the idling of a vast share of the world’s productive resources. Don’t let shortages of a few goods, like face masks or toilet paper, confuse the matter. The consequences will almost surely persist beyond the period of widespread lockdowns.
When you read a news article or hear an economist mention the price of oil, it typically refers not to a physical barrel filled with viscous liquid but to the price of a futures contract that trades on the Chicago Mercantile Exchange. By convention, the “price of oil” is the going per-barrel price reflected in a futures contract for the ensuing month.
In the case of the most widely followed contract in the United States, that would be West Texas Intermediate crude, which you would need to physically obtain from storage facilities in Cushing, Oklahoma, where major pipelines intersect.
Plenty of major entities trade such futures without ever thinking too much about those physical details — and certainly without getting any oil on their expensive suits. Speculators speculate, companies hedge their risks of price swings, and transactions take place at the level of abstraction on a computer screen.
But as each contract’s settlement date approaches, the financial speculators sell their contracts to “real” buyers of oil, like refineries. This can cause problems for traders who may be in over their heads. Chris Arnade, a trader-turned-author, said on Twitter on Monday that he once found himself in that position, “I ended up almost taking physical delivery of lots of oil.”
Tuesday is the settlement day for that May contract. It fell from $18.27 at Friday’s close to the steeply negative numbers late Monday amid a frantic effort by traders to offload oil for which there simply wasn’t enough physical demand or storage capacity.
Over the last six weeks, demand for products refined from oil has collapsed. With far fewer airplanes flying, airlines need less jet fuel. People aren’t driving, so they need less gasoline.
But oil producers have been slower to cut back production, meaning there is a glut. All the usual places to store it are full, and hence the negative futures prices to enable the market to clear. There are only so many storage tanks.
Futures prices suggest that the oil market will work through this, as drillers suspend production. The June futures contract was trading for $21.41 late Monday, and the September contract for over $30. Commodities traders call it a state of “super contango,” with sharply higher prices in the near future than today.
The economic result of the pandemic is, more than anything, a sudden stop of demand. There may be a few products in which shortages are an issue, including medical equipment, personal protective gear and disinfectant wipes. But the overall picture is that a huge share of potential economic output is simply on hold.
That includes obvious candidates like restaurants, airlines and sports arenas, which are sitting empty. It includes the 22 million workers who have filed for unemployment insurance benefits, with many more likely to come. It includes less obvious candidates like the auto industry, which has temporarily shuttered factories. And, we now see, it includes the energy industry, with more capacity to pump oil out of the ground than there is demand for at present, and inadequate storage capacity.
All of that points to a deflationary collapse — a glut of supply of goods and services, and consequently falling prices — that surpasses anything seen in most people’s lifetimes.
Oil isn’t the only commodity with a plunging price. Corn futures have fallen 19% since early February. The price of inflation-protected government bonds suggests inflation will be only 0.56% a year over the coming five years, and the Consumer Price Index fell 0.4% in March.
The good news is that capacity won’t go away overnight. The oil will still be in the ground once the economy starts to recover; the unemployed will be eager to go back to work; the stadiums and restaurants can reopen. But the longer the freeze of the economy continues, the deeper the risks of some permanent damage.
In the oil market, even assuming the negative prices for the May futures contract can be viewed as a bizarre aberration, there is a deeper lesson. A steep rise in American energy production over the last decade has outpaced the world’s need for energy, especially if many of the changes resulting from the pandemic, like less air travel, persist for months or years.
Economics is about supply and demand, production and consumption. The question for the post-pandemic economy is whether that balance, once lost, can be quickly restored. Doing so will be a lot more complicated than finding more places to store West Texas Intermediate crude.