Oil below zero: a lesson for the Bulls.

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Oil has dropped below zero. A historic moment for us all to witness, and there will likely be more historic events as this pandemic unfolds.

A shock to investors, but a lesson that should be learnt for anyone who has been caught up in the recent stock market rally in Mid-March.

This Monday saw oil prices dip below zero with WTI Crude (West Texas Intermediate), the US benchmark for oil, dropping to negative $40 USD. This is an extreme case of supply exceeding global demand, due to OPEC’s (Organization of Petroleum Exporting Countries) over supply position and COVID-19’s downwards pressure on global demand. 

The negative price of oil is due to storage costs, amongst other things. As people shelter at homes and businesses have been forced to close, the commodity has waned in demand. This has resulted in offshore oil tankers increasing their daily storage rates from $30,500 USD per day to $72,500 USD.

The Bulls are quick to note that this is a market technicality as short-term storage costs have caused this reaction on this particular futures contract (a contract that allows traders to speculate on the future price of oil). They are saying that it is very typical for the current price of oil to drop below the future value; it is the nature of trading.

However, everything to one side, oil at negative $40 USD is not the norm. Since mid-March, global stock markets have rallied with the S&P 500, the US benchmark, jumping 26%. This has been due to government intervention from the US Federal Reserve as they pledged to inject $2TN USD into US businesses and bond markets. As the Fed has neutralized the impending threats of COVID-19 to the US economy, this has provided assurance and improved market sentiment.

However, the idea that this is the beginning of an organic recovery as markets return to normality is a bit far-fetched. Peter Oppenheimer, chief global equity strategist at Goldman Sachs has said that “this rally is far too fast and there are still downside risks to be seen”.

Following the perception that a floor price for oil had been reached at the end of March, the drop in oil prices to below zero should serve as a warning to everyone. This is a clear signal that the global economy is in deep trouble and should indicate that this recent spike in the global equity markets is a knee jerk reaction to stimulus packages, not the beginning of an organic global recovery. The worse may be still to come.