What do negative oil prices mean?
Oil futures prices have only turned negative once – in April 2020. Here, we explain what negative oil prices are, how they come about and how you can trade them.
What are negative oil prices?
Negative oil prices are when the price of an oil futures contract falls below zero. In the oil market, the futures price (the price of oil for delivery in the future) is often higher than the spot price (the price of oil for delivery today).
This is because the futures price factors in the spot price, as well as the cost of storing the physical commodity on settlement of the futures contract (known as the cost of carry). To understand negative oil prices, it’s important that you are familiar with two significant futures market conditions: contango and backwardation.
- Contango is the normal market condition, in which the futures price is trading higher than the spot price
- Backwardation is a less common market condition, in which the futures price is trading below the spot price
How do negative oil prices come about?
For oil futures prices to turn negative, a range of different factors need to line up perfectly:
- Demand for oil needs to fall
- Supply needs to exceed demand
- Storage space needs to be running out
If these factors line up, then oil prices could turn negative – providing that effective measures to reduce supply or increase storage space are not taken.
Negative oil rates came about for the first time in history in April 2020 for West Texas Intermediate (WTI) contracts. This happened because the coronavirus caused demand for oil to halt, while supply cuts weren’t scheduled to come into effect until 1 May 2020 – which was after the expiry date for May 2020 futures.
The scheduled cuts are set to steadily decrease, first to 7.7 million barrels a day on 1 July 2020, and then to 5.8 million barrels a day from January 2021 until April 2022. But, because the scheduled cuts are set to start on 1 May 2020, they didn’t do enough to prevent a crash.
Could oil prices go negative again?
Some analysts have already predicted that the price of June 2020 expiry oil futures could also turn negative if further and more dramatic production cuts are not put into effect – and if additional storage space is not created.
Example of negative oil prices
Oil futures have only turned negative once in history, which happened to WTI futures expiring in May 2020. The price went negative on 20 April 2020, a day ahead of the May 2020 delivery (21 April 2020). This meant that anyone who still held a May 2020 contract would have had to take delivery of the physical oil barrels after 21 April 2020.
Usually, traders and speculators can roll these contracts over to the next month, but with demand falling and storage space approaching maximum capacity, they ended up having to pay others to take the oil off their hands.
The reduction in demand that helped to bring about this crash was unprecedented, and it was a direct response to the coronavirus pandemic.
This is because fewer drivers were on the roads, fewer public transport services were running in many countries, offices had shut down after worldwide lockdowns and stay-at-home orders, and factories had ceased production.
Ways to trade on negative oil prices
Even if a market goes negative, IG will continue to price it. You won’t be able to open new positions on the market though, but you can let your existing positions run.
However, you should remember that you will not be able to set negative stops and limits on your positions.
If oil prices are negative and you are unable to trade the market directly, you could still go short on certain assets that are closely related to oil. In this case, some traders will short oil exchange traded funds (ETFs), or they will buy inverse oil ETFs.
You should also be aware, that if you have an open oil position on MT4 and the market turns negative, your trade will automatically be closed out once the price passes zero. We will also suspend oil trading on MT4 – meaning you won’t be able to open new positions – if the market is approaching or hits zero.
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