Story so far: Prices of West Texas Intermediate (WTI), the American benchmark for crude oil, fell to less than zero in Monday’s trade. The price of a barrel of WTI fell to minus, yes, that’s right, minus $37.63 a barrel. What this means is that sellers have to pay buyers to get rid of their crude! This is unprecedented in the oil market, even accounting for its notoriety for being volatile.
Why did prices fall like this?
We need to understand a bit of oil market and trading dynamics here. WTI oil is traded as futures contracts in the NYMEX (New York Mercantile Exchange) where traders buy and sell monthly futures such as, for instance, May futures, June futures and so on. The sellers of such futures will have to deliver a barrel of crude oil at the contracted price in the contracted month just as buyers will have to take delivery at the contracted date.
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As with all trading in commodities, there’s a huge speculative participation in oil futures trading too. So speculators buy and sell contracts with no intention of taking delivery (in the case of buyers) or offering delivery (in the case of sellers) of the physical oil, on the contracted date. These speculators have to unwind their “positions” on the contract expiry date. If they fail to do so, they will have to take physical delivery of the crude oil on the contracted date.
What happened on Monday was that speculators who had taken large bets on May futures began to unwind their “positions”. This was because the futures contracts are set to expire today, Tuesday. Those not intending to take physical delivery have to square off their contracts before the expiry date. So, speculators who did not want to take delivery in May proceeded to unwind their “positions,” leading to the massive fall in prices.
It could be that these were financial spec