How Negative Oil Futures Price Impacts Production

Subscribe to newsletter

A market shock, exemplified by the 1987 crash, denotes a sudden and severe disturbance in financial markets, leading to significant disruptions and abrupt changes in asset prices. This event can have a lasting impact. For instance, prior to the 1987 crash, volatility remained flat. Post the crash, there emerged a volatility skew.

Reference [1] investigated the causes and impact of the negative front-month oil futures price in May 2020. The authors demonstrated that the negative oil futures price was attributed to

  • A real physical constraint (lack of storage), but this constraint can be at least partly caused by non-physical financial traders who obscure the demand signal, and
  • Expiration of a futures contract when financial traders are forced to close their positions without taking physical delivery and the true demand is revealed.

Additionally, the authors also pointed out the impact of the negative futures price on oil production,

Subscribe to newsletter https://harbourfrontquant.beehiiv.com/subscribe Newsletter Covering Trading Strategies, Risk Management, Financial Derivatives, Career Perspectives, and More

This event created a situation where a major oil price benchmark experienced a dislocation from the fundamentals affecting oil prices throughout most of the U.S., and we find that this channel led to real effects. Specifically, oil producing firms react to the elevated risk of a repeat event in May of 2020 by preemptively shutting a portion of their wells in anticipation of future dislocations of the benchmark, despite fundamentals outside of the benchmark delivery location being supported by ample storage availability. Once this risk has receded, firms resume normal operations.

In short, the fear of a repeat event prompted numerous producers, including those in regions not directly affected by storage capacity constraints, to temporarily halt production in May, even though prices had already rebounded to their early April levels.

This article offers additional compelling evidence regarding the impact of a financial shock.

Let us know what you think in the comments below or in the discussion forum.

References

[1]  Gilje, Erik and Ready, Robert C. and Roussanov, Nikolai L. and Taillard, Jérôme, When Benchmarks Fail: The Causes and Consequences of Negative Oil Prices (2023). https://ssrn.com/abstract=4666143

Subscribe to newsletter https://harbourfrontquant.beehiiv.com/subscribe Newsletter Covering Trading Strategies, Risk Management, Financial Derivatives, Career Perspectives, and More

Further questions

What's your question? Ask it in the discussion forum

Have an answer to the questions below? Post it here or in the forum

LATEST NEWSB2Gold Announces Drilling Results from its 2024 Exploration Program at the Goose Project; Drill Results at the Nuvuyak Deposit and Mammoth Target Demonstrate Potential to Further Extend the Mine Life at the Goose Project
B2Gold Announces Drilling Results from its 2024 Exploration Program at the Goose Project; Drill Results at the Nuvuyak Deposit and Mammoth Target Demonstrate Potential to Further Extend the Mine Life at the Goose Project

VANCOUVER, British Columbia, Nov. 13, 2024 (GLOBE NEWSWIRE) — B2Gold Corp. (TSX: BTO, NYSE AMERICAN: BTG, NSX: B2G) (“B2Gold” or the “Company”) is pleased to announce positive exploration drilling results from its 2024 drilling campaign at the Goose Project, part of the Back River Gold…

Stay up-to-date with the latest news - click here
LATEST NEWSWestern Metallica Announces Closing of Private Placement to Advance Peruvian Copper Project
Western Metallica Announces Closing of Private Placement to Advance Peruvian Copper Project

Not for distribution to United States newswire services or for dissemination in the United States TORONTO, Nov. 13, 2024 (GLOBE NEWSWIRE) — Western Metallica Resources Corp. (TSXV: WMS) (“Western Metallica” or the “Company”) is pleased to announce that it has closed its previously announced non-brokered…

Stay up-to-date with the latest news - click here
LATEST NEWSCanada shares U.S. concern over Mexico’s trade practices, Freeland says
Canada shares U.S. concern over Mexico’s trade practices, Freeland says

Mexico has been criticized for being a backdoor for cheap Chinese imports to the U.S. market

Stay up-to-date with the latest news - click here
LATEST NEWSFactbox-Trump turns to Congress for Cabinet picks, whittling away at slim margins
Factbox-Trump turns to Congress for Cabinet picks, whittling away at slim margins
Stay up-to-date with the latest news - click here
LATEST NEWSNextSource Materials Closes Final Tranche of Private Placement for Additional Gross Proceeds of CAD$720,800
NextSource Materials Closes Final Tranche of Private Placement for Additional Gross Proceeds of CAD$720,800
Stay up-to-date with the latest news - click here

Leave a Reply