A Simple Explanation of Wacky Oil Prices

Sometimes commodity traders and refiners need to park their oil for awhile before its final destination. Through a “matchmaker,” their shipments are paired with storage space in tank farms, on ships, in empty salt caverns, in unused pipelines, in railcars.

Now those storage facilities are filling up. You can see that floating storage (gray) and onshore (orange) inventories have skyrocketed:

Oil Price Plunge

At the same time. the price of WTI (West Texas Intermediate) crude oil has plunged.

Fearful that storage could run out in May, some sellers drove price down to a negative $37.63 per barrel because they were  were willing to pay buyers for taking their inventory:

On the supply side, we have an oil glut. During March, OPEC (the Organization of Petroleum Exporting Countries) suspended production cuts. Although some of the world’s oil producing countries will produce less, the offsets are relatively small. Analysts predict that supply will go down by 10% in May–a tepid response to rockbottom prices.

Meanwhile, on the demand side, the EIA (U.S. Energy Information Administration) lists three main reasons that the world wants less crude. They cite shrinking global economic growth caused by pandemic lockdowns. Then, they specifically name air travel. And finally, the last cause is a catchall where they allude to “other reductions in demand not captured by these two categories.”

Below, supply is steady and demand has a dip:

Our Bottom Line: Inelasticity

To explain oil’s unusual behavior, economists could use the word inelasticity.

On the demand side, when price changes a lot and the quantity we buy remains almost the same, then our demand is inelastic. For supply too, price changes can create a reaction. However, if they do not, then supply is inelastic. An example of inelastic demand is the medication we still buy even when price goes up. With supply, it could be the Christmas surge for a toy for which suppliers have an inelastic response because they cannot boost production.

Oil markets are displaying inelasticity. The law of supply tells us that a big price drop should diminish the quantity producers are willing and able to supply. But it has not. Meanwhile, on the demand side of the market, we usually want to buy much more when price goes down. Now though we are not. So yes, all is wacky. With prices at negative levels, individuals are paying people to take their oil.

As a Bloomberg journalist suggests, we can make sense of it all through inelasticity.

My sources and more: When the price of oil turned negative, the articles multiplied. I started with The Indicator podcast for a 9 minutes quickie summary and followed with this NY Times look at a storage matchmaker. Next, Reuters and Bloomberg had some helpful facts. Finally, for basic stats, EIA is ideal.

Our featured image is a NY Times image of a Saudi Aramco tank farm in the Persian Gulf.