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Commodities

Four things to know about the historic oil price plunge

Crude treated like 'garbage' shows turmoil in world's largest commodity market

A crude oil pump jack and flare burning excess gas in Texas. A key U.S. oil price contract turned negative for the first time on Monday.   © Reuters

TOKYO -- Even in a world becoming more used to the convulsions of the coronavirus pandemic, the breakdown in oil trading -- turning the price negative for the first time in history on Monday, followed by more turmoil on Tuesday -- has been astonishing.

West Texas Intermediate, a reference benchmark for U.S. oil trading, plummeted to a barely comprehensible -$37 per barrel on Monday. At any price below zero, sellers of oil are paying buyers to take it off their hands.

Oil is now behaving like "garbage", said Tomomichi Akuta, chief researcher at Mitsubishi UFJ Research and Consulting.

While a number of specifics connected with oil trading triggered the fall into negative territory, analysts say that without a clear end in sight for the coronavirus pandemic, the world can expect to continue to see weak oil demand and low prices.

Here are four things to know about what is happening in the oil market and what this means for Asian countries -- major oil consumers.

Why did a benchmark price turn negative?

There are two major reasons. First, demand has been obviously decreasing as the coronavirus spreads around the world. Many countries took preventative measures including social distancing, restrictions on going out and prohibitions on international travel. This has sharply reduced demand for oil for transportation via vehicles and airplanes.

According to an estimate published last week by the International Energy Agency, global oil demand this year is expected to fall by 9%, or 9.3 million barrels per day. Before Monday's crash the WTI price had already sunk to $18 per barrel, its lowest in 18 years.

Secondly, there is a technical reason. In the futures market, investors have to end the contract by doing a reverse trade by a certain expiry date, or buyers have to take physical delivery of the oil. The contract of WTI crude for May delivery, which was most actively traded, expired on Tuesday, so many investors who had bought oil rushed to sell to close the trading.

"Negative oil prices mean that producers are effectively willing to pay someone to move their crude," said Goldman Sachs in a report issued on Tuesday. The price plummeted into negative territory because there were very few buyers and many sellers had trouble finding those who can take oil.

Will the negative price happen again?

Latest trading suggest it is not out of the question given the collapse in demand. On Tuesday the price of WTI crude for June delivery hit $6.50 a barrel. The price is at $13 a barrel as of Wednesday. The WTI crash triggered sell-offs in the global stock market. The Dow Jones Industrial Average plunged 2.7% on Tuesday and Japan's Nikkei 225 dropped 2.5% at one point on Wednesday.

U.S. President Donald Trump downplayed the historic oil price plunge as a short-term problem. However, some analysts believe further temporary periods of negative prices could occur.

In the U.S., as economic activities are slowing down, there is more oil supply than demand. As a result, many refineries are overstocked and it is becoming more difficult for oil buyers to secure storage. "It is estimated that American oil storage facilities will be full in around nine weeks," said an industry source.

Without demand and enough storage capacity, the oil will have no place to go. The industry expert said that "it is likely that investors will have to rush to sell oil when the expiry date [for contracts] is coming closer."

Tankers in the Strait of Singapore (Photo by Ken Kobayashi)

What are oil-producing countries doing?

In a few words: not enough. Last month two major oil-producing countries -- Saudi Arabia, the de facto leader of the Organization of Petroleum Exporting Countries, and Russia, which is not in Opec -- helped to start the oil market downturn by failing to agree on a production cut.

This month this "Opec+" group did agree to reduce oil production by 9.7 million barrels per day. However, analysts warn that this is not enough. The IEA estimates that the oil demand will decrease by 29 million barrels per day in April, while another industry expert told Nikkei he expected demand to drop by between 20 million and 35 million barrels per day until June. "The supply cut is not only insufficient but also lacks an immediate effect," he stressed.

With oil prices falling, Trump on Tuesday ordered Treasury Secretary Steven Mnuchin to formulate a plan to get funding to the U.S. oil and gas industry. "We will never let the great U.S. Oil & Gas Industry down," Trump tweeted.

As demand continues to remain low, OPEC+ might need to step in to cut supply further. However, it remains uncertain to what extent the supply cut will contribute to recovery in oil prices, unless the pandemic ends.

What does this mean for Asian economies?

Usually, a decline in oil prices benefits Asian economies that in general are major buyers and consumers of oil. However, experts are skeptical about a commonly accepted theory that lower oil prices can stimulate the economy.

"First of all, the oil price drop resulted from the severe financial crisis caused by the COVID-19 pandemic," said Tatsufumi Okoshi, senior economist at Nomura Securities. "Under such a situation, we cannot expect positive effects. Rather, there is a more negative impact on Asian companies that sell products to overseas oil companies," Okoshi added.

And Mitsubishi's Akuta said the deterioration in business conditions for energy companies and financial deterioration of oil-producing countries could "destabilize global financial markets," which would negatively affect Asian economies.

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