The price on the futures contract for the US grade of crude oil (West Texas) fell to minus $37.63 a barrel but countries like Bangladesh will not be benefitted from the opportunity even in the midst of this pandemic. Photo: Reuters
"Truth is stranger than fiction, but it is because fiction is obliged to stick to possibilities; truth isn't."
Mark Twain's words from "A journey around the world" are indeed applicable to what the entire world witnessed on Monday, April 20th, when oil prices entered negative territory.
The price on the futures contract for the US grade of crude oil (West Texas) fell to minus $37.63 a barrel. With the Covid-19 pandemic bringing the global economy to a halt, the volume of unused oil had American energy companies on their toes as they ran out of room to store it.
Contracts that were due to expire on Tuesday April 21 for delivery in May had oil traders cancelling their obligations, causing an unsolicited surge in excess supply, escalating the madness. With no place to store the oil, everyone seemed reluctant for a crude contract that was about to become due.
The negative prices imply that sellers were forced to pay to have the crude taken out of their possession. The European benchmark, Brent crude for June delivery pulled back more than 2% when the markets opened on April 21, but eventually reversed its price trajectory and was trading around 3% lower, with a barrel exchanging hands for $18.73.
To make matters worse, the price war between Saudi Arabia and Russia had investors in shackles. The two countries concluded a dispute earlier last month along with other top oil producers, agreeing to slash output by nearly 10 million barrels a day to support the virus-struck markets. However, by Wednesday April 22, the US benchmark West Texas Intermediate (WTI) for June delivery was trading upwards by nearly 10% at $12.68 a barrel, reflecting gains of around 20% during opening hours in Asia.
But what caused such an unprecedented price decline for a commodity that has always been in high demand? The US produces the WTI grade of crude oil, while the oil fields in the North Sea produce Brent crude; Dubai, Oman, Abu Dhabi and other middle eastern countries produce Dubai/Oman crude etc.
The demand for oil has gone down due to a global lockdown. Fuel is essential for everything in a "functioning economy", from shipping goods, flying planes, commuting to work, powering industries and so on. This falling demand due to the lockdown has been further aggravated by the US government's failure to convince oil producers to reduce their output, since it's not very convenient to shut down the oil fields.
In general, oil is always traded on its future price. This means that the contract to buy next month's oil is decided in the current month. If any particular entity wants to purchase a million barrels of oil in May, the order for May is placed in April and the rates are predetermined.
The price of ($37.63) was the delivery price for May, and Tuesday 21 April was the expiry date for these future contracts to be executed for ensuring delivery in May. The investors who were supposed to take their deliveries for May didn't wish to receive the delivery because of the lack of storage spaces.
However, the price for June 2020 oil futures contracts are estimated to be $13.80, with July prices looming around $30 per barrel. This means that oil traders and analysts expect a rise in demand as lockdowns around the world are slowly lifted.
Furthermore, oil traders expect that the US government will create excess storage space to facilitate for the current situation. This could be achieved through the utilisation of its national reserves to buy and store the excess oil.
"The law of demand" in economics states that price and quantity demanded of any good or service are inversely related to each other. When the price of a product increases, the demand for the same product will decrease. So, a negative oil price is a desperate step by the oil industry in the US to increase the quantity of oil purchases. As a result, a negative commodity price (as is the case here for oil) is only temporary and will soon be adjusted according to future developments.
Many think that this has presented Bangladesh with a unique opportunity. State owned Bangladesh Petroleum Corporation (BPC) had been a loss-making entity living off government subsidies for many years until the last decade. Of the two oil trading markets in the world, Singapore and the United States, Bangladesh buys its oil from Singapore. Oil prices in the region are determined by Platts, a Singapore-based energy and metals information provider used as a benchmark for assessing prices of physical energy commodities.
According to a recent report by Prothom Alo, BPC purchases oil for Bangladesh in two ways: Government to Government (G2G) and international tenders. Amongst the two options, 1.5 million tons of crude oil is purchased directly from Saudi Arabia and Abu Dhabi on a G2G basis. Refined oil is purchased from eight different companies across seven different countries on a G2G basis. Whereas regular oil is bought only twice a year through international tenders.
Regardless of the method used to acquire the oil, the price of oil remains unchanged. It is the premium that is negotiated. The price two days before loading the ship for BPC, the price the day the ship was loaded, and the price of the following two days, as published by Platts Magazine, are adjusted via averaging, to arrive at the price of oil per barrel.
In simple terms, it is a weighted average of the prices of the five days during which the oil was loaded for delivery. If the ship started loading oil for BPC on April 20, the price of oil to be invoiced will be calculated as the average five-day oil price on April 18, 19, 20, 21 and 22 in accordance to the metrics published in Platts.
Either way, regardless of whether oil is bought via G2G agreements or international tender, the only item worth bargaining for is the premium. Premium includes several aspects like freight charges, international taxes, VAT, service charges, insurance etc. Bangladesh is currently procuring 1.6 million tonnes of oil from Vitol and UNIPEC. The two entities received the order regarding purchases in December 2019, when the price of oil was trading around $64 per barrel.
BPC will still get oil at the current market prices due to declining oil prices. However, the premium of $2.33, which was already received by the two companies as the lowest bidder, shall remain fixed.
Thus, as it turns out, neither will negative oil prices persist nor will countries like Bangladesh benefit from the opportunity even in the midst of this pandemic.
Sayeed Ibrahim Ahmed is a senior lecturer in Finance, American International University- Bangladesh (AIUB).