Business Acumen: oil price fluctuations during COVID-19
Lecturer and Business Acumen Subject Controller, Calum A. Macdonald CA, explores recent oil-price fluctuations during COVID-19 and links them to Business Acumen principles.
For the first time in history (in April 2020 – during the COVID-19 pandemic), the price of US oil (West Texas Intermediate Crude Oil) became negative. This is a prime example of the impact that the COVID-19 situation has had on the economy.
This means that oil producers were paying buyers to take oil off their hands, mainly because they feared that the capacity to store oil could run out shortly.
The price of oil fell negative and ultimately dropped as low as minus $37.63 per barrel.
The market mechanism
In Business Acumen, we study the market mechanism. Under a normal market mechanism (for a normal good such as oil), as the price of a product increases, the quantity demanded decreases and the quantity supplied increases. This is because consumers are less willing to purchase a normal product at a higher price, however, suppliers are more willing to produce/sell a product if they are receiving a higher selling price for that product.
During COVID-19, demand for oil collapsed due to a reduction in fuel needed to ship goods, to commute to work or for air travel. As oil was not needed in such vast quantities as is usually the case, the US began to run out of places to store all of the oil that oil companies had continued to pump from the earth.
This meant that traders of oil commodities were willing to pay consumers to get rid of oil rather than trying to store it.
This is demonstrated in the above graph where, as the price rises (on the Y axis), the quantity demanded reduces and quantity supplied increases. This is generally how the market mechanism works for products that conform to both the law of demand and the law of supply.
In this situation, there is excess supply, which is when the quantity that producers are willing to supply is higher than the quantity demanded by consumers. As a result of this, manufacturers had excess inventory and competition among manufacturers put a downward pressure on price. With the fall in prices, consumer demand steadily increased until it settled at the equilibrium price.
This negative price only applied to oil contracts for delivery during May 2020 and the price was available immediately before that contract expired. Therefore, a buyer could buy oil (and get paid as much as $37.63 per barrel), store for around a month and in June, they could sell it in the market for around $20 per barrel.
That being said, oil in other parts of the world and for delivery at a later date, has also been suffering price drops. This is essentially the market's way of telling us that it is in deep distress. Going forward, this will be a struggle for oil producers.