RIGging the collapse

The idea of a high price for the high demand is plain common sense; you don’t need a degree in economics to understand the basics of supply and demand. What becomes interesting is the roles of seller and buyer are reversed, and the seller is paying the buyer to offload the oil. We are referring to the negative West Texas Intermediate Futures price.

The costs of shutting down and starting a rig are costlier than bearing the marginal losses. The buyer, on the other hand, has his hands full. He would incur higher transportation and storage costs than the value of the oil itself.

A similar situation occurs in electricity markets as well, during the mid-day when wind, solar, hydro, and thermal-based electricity producers are generating electricity the supply is higher than the demand. The solar wind hydro can stop their production relatively easier while for coal-based plants, the costs of starting and shutting down the plant are huge. They continue to produce during negative pricing situation as well ensuring they provide electricity when the demand peaks during the evening.

Now coming back to Oil markets, when the oil prices started declining no player was ready to decrease the oil production fearing they will lose market share while demand kept falling as much as by 30%. The countries and traders stocked the oil, and they were left with no storage. The May contracts of American crude were to expire by April 21st. So, when the deadline arrived the prices started to plummet because the oil trader wanted to get to rid of oil instead of shutting production which would be costlier to restart than losses of the May sales by the contract. From consumers holding the contracts wanted to avoid the buying as there was no space to take the delivery. It was leading to the futures price that went negative on April 20th.

Negative oil prices seem like a crazy event, but can we draw parallels to the losses incurred by e-commerce companies to earn market share? The food delivery start-ups like Uber eats, Zomato and Swiggy were all paying us to buy from them. One can draw parallels to rich countries paying the poor to dump their waste. Nothing comes free, after all. In every such transaction, one wins, and others believe it was her.



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EPS, IIM Kozhikode

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