So, we’ve seen the headlines that the price of oil at the end of the day on 4/20 was negative $35/barrel. That’s quite a headline, but what does it mean for us? We’re going to try and explain the situation over the next few days to hopefully provide a little clarity and give you an idea about what to look for and expect in the next few weeks and months.
To get started, let’s get acquainted with some terms:
- Crude Oil – This is the stuff that gets pulled out of the ground. It can have slightly different chemistries, but they are all essentially the same. Crude is refined into aviation fuel, diesel, gasoline, wax, solvent, tar and few other things. One of those things is base oil which is used to make the products our company manufacturers and sells. You get half of a gallon of base oil out of a barrel of crude. Base oil is a by-product of making aviation fuel, gasoline and diesel. If the refinery is not making any of those, they are not producing base oil. Crude oil comes in 42-gallon barrels.
- Benchmark – This is the “price” that gets referred to in the headlines. There are three primary benchmarks that represent three areas of the globe; West Texas Intermediate (WTI), Brent (basically European oil out of the North Sea) and Dubai Crude (sourced from the Middle East). Each of these usually has a similar price. Remember that there are multiple benchmarks, this will be important later.
- Price – This is what a barrel of oil costs at a given time for a specific contract. The price you see in the headlines is the last price negotiated for a contract. This is NOT like a stock price where all the outstanding stock shares are worth exactly the same as the price we see when we look at the stock market. For contracts, the price remains the same as when it was negotiated between the two parties. Unless of course, somebody to decides to re-sell that contract, then the price could be different. Remember, the crude price you see is for the last contract sold that day and only applies to that specific contract. This is important to understand what’s happening.
- Contract – Here’s where it gets goofy. A supplier and buyer can enter into a contract to buy/sell crude oil nine years in the future. Each contract is worth 1,000 barrels. The contract price is negotiated for a particular month and the buyer must take physical ownership of the crude on a certain date. The date is complicated, but important for what happened the other day. The date to take delivery is the last Tuesday of the prior month as long as that day is before the 25th of the month. If you entered into a contract to purchase oil in February of 2020, you would have to take delivery of the product by January 23, 2020. Bring out your calendars and see when you would have to take possession of crude if you entered into a May 2020 contract. There will be a test.
- Traders – While there are some contract buyers that will actually use the crude, most buyers will never actually use the stuff. These are traders and they will buy contracts and hope there is some event that will cause a price increase for crude oil. This could be a war in the Middle East that causes a shortage or an exploding middle class in a developing country that will create a huge demand for gasoline, diesel and aviation fuel. If the demand from end users like refineries increases, the refiners are willing to pay more for crude because they don’t have enough to meet demand. If a trader has a contract for $20/barrel, they might be able to sell it to the refinery for $25/barrel and make a tidy profit. Remember, though, whoever holds the contract on the last Tuesday before the 25th must take possession of the crude.
All right. Hopefully we have some understanding of the crude market. Next, we’ll go into what happened leading up to the events of 4/20.
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