What the Negative Price of Oil Is Telling Us We’re in a deflationary moment that surpasses anything seen in most people’s lifetimes. • • • Share on Facebook Post on Twitter Mail By Neil Irwin • April 21, 2020Updated 6:21 a.m. ET Image Oil pipelines running to storage tanks in Cushing, Okla.Credit...Nick Oxford/Reuters 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, Okla., in the month of 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. ADVERTISEMENT 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, Okla., 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. ADVERTISEMENT 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. ADVERTISEMENT 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. ADVERTISEMENT Oil isn’t the only commodity with a plunging price. Corn futures have fallen 19 percent since early February. The price of inflation-protected government bonds suggests inflation will be only 0.56 percent a year over the coming five years, and the Consumer Price Index fell 0.4 percent 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. Neil Irwin is a senior economics correspondent for The Upshot. He is the author of “How to Win in a Winner-Take-All-World,” a guide to navigating a career in the modern economy. @Neil_Irwin • Facebook Oil price jumps 18% after reports that a key measure of storage demand was 2 million barrels lower than expected Shalini Nagarajan Apr. 29, 2020, 06:51 AM Reuters • • • • • • Oil bounced 15% on Wednesday against a backdrop of slowing demand for inventory storage. Wednesday's gains came after the American Petroleum Institute reportedly said that US oil inventories rose by just shy of 10 million barrels last week. That was significantly lower than the 12 million barrel increase expected by analysts, the Financial Times reported. Oversupply fears had seeped into selling pressure on oil-exchange traded funds that have been pulling back from the June contract. In morning European trading, West Texas Intermediate oil rose 18% to $14.57 a barrel and Brent rose 5% to $23.89 a barrel. Watch oil trade live with Markets Insider. Oil prices rebounded on Wednesday, after reports that a key measure of oil inventories showed lower than expected demand for storage and oil-focused exchange traded-funds appear to have finished selling June futures contracts. West Texas Intermediate crude futures rose 18% to $14.57 a barrel as of 8.35 a.m. ET. The international benchmark Brent crude rose 5% to $23.89 a barrel. Wednesday's gains came after the American Petroleum Institute reportedly said that US oil inventories rose by just shy of 10 million barrels last week. That was significantly lower than the 12 million barrel increase expected by analysts, the Financial Times reported. Those figures suggest that storage demand amid the coronavirus is slowing, a likely boost for market sentiment. The popular oil ETF USO pulled out of its June contract and said it would sell all its futures contracts for oil delivery in June, in favour of longer-term contracts. The oil market has been in turmoil with mounting hedge fund selling and after prices tanked again by 21% on Tuesday. Read more: The manager of the best small-cap fund of the past 20 years explains why he's betting big on a consumer recovery — and shares his top 4 stock picks in the struggling sector Analysts, however, warned that gains are likely to be short-lived, with one predicting "carnage" in the oil market in coming weeks. "Carnage will remain as long as the market remains so incredibly imbalanced and we get closer to mid-May when storage facilities are expected to be full to the brim," said Craig Erlam, senior market analyst at OANDA. "Those cuts can't come soon enough." "Oil trade will remain volatile, but any major relief rallies will likely be heavily sold into until the entire energy space starts delivering deeper production cuts," according to Edward Moya, another senior market analyst at OANDA. "Given that inventory increases are still running at extreme rates we may still be seeing such violent moves in WTI futures without the fund rolls," analysts at Deutsche Bank said. The US Energy Information Administration's inventory report and the release of global floating storage data later today would be noteworthy. Managerial Economics WEEK 1 LECTURE Market Fundamentals Outline • Market Demand • Market Supply • Market Equilibrium • Price Restrictions • Comparative Statics What is Managerial Economics? • Manager • Economics • Managerial Economics And that goal would be… To maximize Profit. But what exactly is profit from an economic point of view? • Accounting Profits: • Economic Profits: What is an Opportunity Cost? • Accounting Costs • Opportunity Cost The Five Forces Framework •Entry Costs •Speed of Adjustment •Sunk Costs •Economies of Scale Entry Power of Input Suppliers Power of Buyers •Supplier Concentration •Price/Productivity of Alternative Inputs •Relationship-Specific Investments •Supplier Switching Costs •Government Restraints Sustainable Industry Profits Industry Rivalry •Concentration •Price, Quantity, Quality, or Service Competition •Degree of Differentiation •Network Effects •Reputation •Switching Costs •Government Restraints •Switching Costs •Timing of Decisions •Information •Government Restraints •Buyer Concentration •Price/Value of Substitute Products or Services •Relationship-Specific Investments •Customer Switching Costs •Government Restraints Substitutes & Complements •Price/Value of Surrogate Products or Services •Price/Value of Complementary Products or Services •Network Effects •Government Restraints Types of Market Interactions • Consumer-Producer Rivalry • Consumer-Consumer Rivalry • Producer-Producer Rivalry • The Role of Government Market Demand Curve • Shows the amount of a good that will be purchased at alternative prices, holding other factors constant. • Law of Demand: The Demand Curve is Downward sloping. Price D Quantity What determines demand? ◆ Income – Normal good – Inferior good ◆ Prices of Related Goods – Substitutes – Complements Advertising and consumer tastes ◆ Population ◆ Consumer expectations ◆ Inverse Demand Function • Price as a function of quantity demanded. • Example: – Demand Function • Qxd = 10 – 2Px – Inverse Demand Function: • 2Px = 10 – Qxd • Px = 5 – 0.5Qxd Change in Quantity Demanded Price A to B: Increase in quantity demanded 10 A B 6 D0 4 7 Quantity Change in Demand Price D0 to D1: Increase in Demand 6 D1 D0 7 13 Quantity Consumer Surplus • • The value consumers get from a good but do not have to pay for. So it’s the difference between the actual price and the price people were willing to pay • Example: Feeling like you got a bargain implies CS was high. Discrete Look at CS Price Consumer Surplus: The value received but not paid for. Consumer surplus = (8-2) + (6-2) + (4-2) = $12. 10 8 6 4 2 D 1 2 3 4 5 Quantity Continuous Look at CS Price $ 10 Consumer Surplus = $24 - $8 = $16 Value of 4 units = $24 8 6 Expenditure on 4 units = $2 x 4 = $8 4 2 D 1 2 3 4 5 Quantity Market Supply Curve ◆ The supply curve shows the amount of a good that will be produced at alternative prices. Price ◆ Law S0 of Supply – The supply curve is upward sloping. Quantity Determinants of Supply ◆ ◆ ◆ ◆ ◆ ◆ Input prices Technology or government regulations Number of firms – Entry – Exit Substitutes in production Taxes – Excise tax – Ad valorem tax Producer expectations Inverse Supply Function • Price as a function of quantity supplied. • Example: – Supply Function • Qxs = 10 + 2Px – Inverse Supply Function: • 2Px = 10 + Qxs • Px = 5 + 0.5Qxs Change in Quantity Supplied Price A to B: Increase in quantity supplied S0 B 20 A 10 5 10 Quantity Change in Supply S0 to S1: Increase in supply Price S0 S1 8 6 5 7 Quantity Producer Surplus ◆ The amount producers receive in excess of the amount necessary to induce them to produce the good. Price S0 P* Q* Quantity Market Equilibrium • The point were Quantity Demanded equals Quantity Supplied • Occurs at a single price • “Steady-State” – once we reach this equilibrium, the market should stop changing What if Price is too Low? Price S 7 6 5 D Shortage 12 - 6 = 6 6 12 Quantity What if Price is too High? Surplus 14 - 6 = 8 Price 9 S 8 7 D 6 8 14 Quantity Price Restrictions • Price Ceilings – The maximum legal price that can be charged. – Examples: • Gasoline prices in the 1970s. • Housing in New York City. • Proposed restrictions on ATM fees. • Price Floors – The minimum legal price that can be charged. – Examples: • Minimum wage. • Agricultural price supports. Example: Impact of Rent Control Price S PF P* P Ceiling D Shortage Qs Q* Qd Quantity Example: Impact of Minimum Wage Price Surplus S PF P* D Qd Q* QS Quantity Comparative Static Analysis • How do the equilibrium price and quantity change when a determinant of supply and/or demand change? Application • The WSJ reports that the prices of PC components are expected to fall by 5-8 percent over the next six months. • Scenario 1: You manage a small firm that manufactures PCs. • Scenario 2: You manage a small software company. • In each case, what should you do? Expand or Contract business? Solution: Impact of Price Decline in PC Components Price of PCs S S* P0 P* D Q0 Q* Quantity of PC’s Impact of Lower PC Prices on Software Market Price of Software S P1 P0 D* D Q0 Q1 Quantity of Software Conclusion • Use supply and demand analysis to – clarify the “big picture” (the general impact of a current event on equilibrium prices and quantities). – organize an action plan (needed changes in production, inventories, raw materials, human resources, marketing plans, etc.).
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