The trade war between Russia and Saudi Arabia continues to escalate as they increase production and as the world economy is entering a global recession, how bad will the oil markets across the world be impacted? The possibility of negative oil prices has been trending across many economic publications.
How does a commodity reach negative prices? While this occurrence is extraordinary and rare, it is a possibility that has occurred before in the past, especially when it comes to oil.
For those who are still wondering; yes, negative prices mean that you are paid to receive a commodity. Instead of buying oil, some oil companies may start paying consumers to take the oil products off their hands!
4 years ago, during another major price drop, North Dakota sour crude was briefly priced at negative 50 cents a barrel before being revised to a mere $1.50.
Sine the price of oil is controlled by global supply and demand, and with the sinking of oil prices that hit an 18-year low as the oil-price war between Saudi Arabia and Russia rages on, oil producers are left with two choices. Either sell their crude at a loss due to their high production cost or decrease production and incur losses due to sub-optimal production.
To avoid a lose-lose scenario, some oil producers continue usual production, and instead of selling at a loss, they use up their storage facilities hoping to ride out whatever global price war or political disturbance may be happening.
What follows is quite obvious. Oil storage is a difficult and expensive operation. Not having enough storage could lead to disastrous effects, and the oil then becomes a burden instead of a commodity due to the complicated nature of halting production completely.
In this scenario, prices will drop to below zero to help the producer free up storage after they have used up all their facilities. They must incentivize a market that has absolutely no need for additional oil and that is by offering them money.
Other Examples for negatively priced commodities is when some towns in parts of the world in desperate need of inhabitant, offer money for people to live in the town and commit to living there for a number of years. This is like signing a rental contract where the landlord pays you every month instead.
While the negative oil prices are unlikely to become a global phenomena which would require multiple instances of seismic catastrophes, some oil producers may incur storage shortages, due to mismanagement, which may lead to negative oil prices.