What is the meaning of negative oil prices?

Investors should get used to distortions in the market every time we face a crisis. Going back in time, until the financial crisis in 2008, we learnt that interest rates could not be negative. Why should I lend money if in the future I will receive a smaller amount? The tremendous crisis suffered during that time has altered one of the fundamental laws of economics and, from then on, investors accustomed to the idea of interest rate below zero. The oil crisis has changed another cardinal concept of economics: price must be positive. Who is willing to sell a product paying customers? On the 20th of April, we observed another historical change: the WTI (West Texas Intermediate) futures price[1] of contracts expiring in May turn negative in the evening, touching the level of $-40.32 per barrel of oil. However, the problem principally stemmed from a very technical issue concerning the dynamics of the derivative contracts[2] (we will explain it later). Before going into technicalities, it is necessary to briefly outline the oil price context and pinpoint the macroeconomic background.

Until the outbreak of the coronavirus, in 2019 the daily production of barrels of oil amounted at around 80.6 mln bbl/day (read barrels per day). The United States was the top producer with around 15 mln bbl/day, followed by Saudi Arabia and Russia[3].

With the OPEC+ agreement, extended to other countries, it was decided to cut the oil production of 9.7 mln bbl/day. Still, it was probably not enough to handle the global shock in the demand deriving from flights drop of around 90%, reduction of car traffic, slower production of chemicals products and so on. Indeed, the most essential commodity has been rapidly losing value since the persistent oversupply overcomes the world’s crude tanks, pipelines, and supertankers. The consequence was that the US oil price crashed and for the first time we saw a price below zero. For producer it is more convenient to pay someone to get rid of the barrels of oil rather than either shutting down the production or finding a location where to temporarily store the excessive supply. Most of them are concerned about closing down wells because the inactivity can create some damages, making the business unprofitable for the future. Another crucial detail is that oil is traded with futures contracts with physical delivery[4]. The buyer must take the delivery of the underlying asset in a specific location at expiration (for example, for the WTI, the location is Cushing, Oklahoma). However, in the futures market, there are traders who buy contracts just to speculate on price swings, but they have absolutely no willingness to take physical delivery. In extreme cases of a deep reduction of price, they may decide to look for a place where to store the barrels.

The problem was that the pandemic has created an excessive oversupply which made storage capacity very limited and expensive. Thus, most traders decided to sell at a loss. This is basically the reason why for the first time we saw a negative price on the financial market. It must be pointed out that it was related to the futures contracts expiring in May and that the ones expiring in June did not have the same behavior. We do not have to be very surprised if in the upcoming future we will encounter again in a similar situation. Despite that, the behavior has impacted also June contracts, which lost part of their value, and other types of oils such as Brent. However, being the Brent a seaborne crude, traders were able to ship it around the world in areas with higher demand. In the worst case, companies rent some tankers and fill them waiting for positive periods. Vice versa, for the WTI this solution is more expensive since it is not extracted next to the sea.

We mentioned the two widely used benchmarks in the oil prices, namely Brent and WTI. The main difference between these two types of crude concern composition. Both are classified as sweet light crudes, a term linked to crude oil containing less than 1% sulfur and that are less dense than other crude oils. WTI has a sulfur content of 0.24% while Brent of 0.37%[5]. Moreover, respectively, they count 39,6 and 38 of API gravity[6]. Clearly, another difference regards the extraction location. WTI is extracted from oil fields in the United States, in Texas, Louisiana, and North Dakota and is then transported via pipeline to Cushing, Oklahoma for delivery. Brent crude is extracted from oil fields in the North Sea.

* The chart takes into account future contracts roll over (the maturity of a position is extended forward for the same underlying asset at the current market price). Monthly prices.

The different properties and geographies explain the price differential between Brent and WTI, technically defined as quality spread. Despite that, as we can see from the chart, prices are perfectly correlated[7], and the lack of demand influences all types of oil. The consequences may impact the surrounding multi-billion market.

Oil producers are suffering large losses (the last to report was Eni, with a €2.9 bln loss[8]) putting a strain on liquidity and solvency risk. The plunge in price exposes the weaknesses of the most indebted companies in the US and a potential spillover effect on other sectors must not be excluded. Currently, a large part of high yield bonds is under the distressed area[9] in the Oil&Gas industry. Companies are trying to reduce cash out, cutting for example dividends and new investments, but, if the crises will protract for a longer period, some oil companies will struggle to survive, especially in a deeply oversupplied market. Rating agencies may start the ripple effect by downgrading these companies. In the future, if many firms will be rated in the non-investment grade area, the new debt issuance might be costly and complicated in a period of credit restrictions.

Unfortunately, the first way to remain competitive on a market with compressed demand is to lay off workers, radically the fastest way to reduce costs and survive in a very turbulent market. Oil price is also the main towing to maintain inflation in a positive area. With a so cheap price, we may expect a possible deflation or very low inflation. The Wall Street Journal has analyzed the possible spillover effects of the oil crisis highlighting that the Real Estate sector is already suffering in Houston due to the oil crisis. Furthermore, some banks, mainly the ones close to the extraction area, lent an important portion of their capital to Oil&Gas companies which now are very close to default (there are more than one thousand producers and most of them are relatively small). Credit Default Swaps[10], a sort of insurance that investors try to obtain against the failure of a company, on oil firms have exponentially widened their spread providing a very negative signal about financial stability. Likewise, bid-ask spread on corporate bonds, an indicator of market liquidity, has widened. Trading has become more difficult since liquid instruments have transformed into illiquid instruments.

The plight to have a domino effect is real, people do not have to underestimate the financial crisis that the oil price might trigger. The failure of some companies in this industry might generate some troubles for other sectors. The default risk is imminent, and oil producers, together with government, must take unidirectional action to support prices because, at the current state, it is risky for the entire economy. Possible effects? credit contraction, unemployment, defaults, deflation, and finally recession.

[1] Agreement to trade an underlying asset at a predetermined price and time

[2] https://www.investopedia.com/ask/answers/12/derivative.asp

[3] https://www.eia.gov

[4] It differs from the cash settlement where it is only transferred the net cash position. https://www.wallstreetmojo.com/cash-settlement-vs-physical-settlement/

[5] The lower the sulfur content the ‘sweeter’ the oil and the easier it is to refine

[6] The gravity of the oils is rated on a scale from 10 to 70, where the higher the number the less dense the oil.

[7] https://www.investopedia.com/terms/p/positive-correlation.asp

[8] https://www.eni.com/en-IT/investors.html

[9] Financial distress is a situation in which a firm is not able to meet its financial obligations, it might unable to payback its debt or just a portion of it

[10] https://www.investopedia.com/terms/c/creditdefaultswap.asp

Are financial markets discounting the coronavirus effects?

In the current environment of protracted uncertainty, the global economic growth outlook has significantly changed due to the COVID-19 effects. The whole economy is facing a series of fundamental macroeconomic and structural challenges which are leading to an impressive slowdown: the health crisis has quickly become an economic crisis and it is gradually turning into a financial crisis.

The recent stock market crash is probably just the beginning of a series of unfortunate events. The partial recovery experienced by the markets in the last weeks is only a small detour from the negative path undertaken since the beginning of the crisis. Intraday volatility, up-and-down price oscillation within the trading session, can be a proxy for the uncertainty of the investors about the future financial performances of an asset or the whole financial market. Recently this indicator has reached extreme levels. An additional proof of the investors’ concerns is given by the volatility index (VIX), typical measure for the market sentiment. The VIX touched the incredible bound of 82 on the 16th of March[1]. In the last 5 years the highest value of VIX has been 30, with an average of 15. Observing its time series, we notice that the value was even higher than the severe crisis in 2008.


VIX trend since 2007

Undeniably, the first quarter in 2020 was one of the worst in the history and, for severity, can be only compared with the one of the financial crisis in 1929. Nonetheless, we do have elements to believe that the coronavirus effects are still not fully embedded in the stock prices. There are two crucial factors to consider.

Firstly, before the coronavirus, analysts were expecting a market correction. It was estimated that financial markets were deeply overvalued (market value was extremely higher than the fundamental value). For example, the S&P500 intrinsic value was evaluated to be around 20% lower than its market price and, as of the 7th of April, the American index has left around 18% on the floor from the beginning of the crisis.

s&P500 trend since January 2020

The second factor concerns the oil price war between the UAE and Russia which has dramatically contributed to a further decrease in the stock market. To face the drastic reduction in oil consumption (demand) due to the global lockdown, oil producers should have cut their production (offer) to support the price. Unfortunately, because of political issues, the two countries did the opposite, started to produce more barrels per day, generating turbulence while uncertainty mounted. The inevitable consequence was a critical drop in the oil price, which has more than halved in just a few weeks. Last Thursday (2nd of April), Trump’s tweet concerning the agreement between the UAE and Russia drove the oil price rally and future[2] prices gained around 30% in just a few days. In any case, the crucial meeting was the OPEC+ where, exceptionally, were invited Texas and Canada and it was signed an agreement to cut the oil production of 10 million barrel per day. Despite that, according to Rystad Energy[3] (a valuable independent energy research company), the global Capital Expenditures (CapEx) – measure of the amount invested by a firm in renovating or maintaining its properties, buildings, industrial plants, technologies or equipment – for exploration and production firms is expected to drop by up to $100 billion this year, around 17% versus 2019 levels. In 2021 the drop could be subjected to a further intensification since many companies (i.e. Eni) have already announced that the CapEx reduction will increase to 30-35%[4]. The oil crisis has already characterized some troubles: McDermott, one of the main firms in the industry, announced that it had filed for Chapter 11 bankruptcy, canceling all shares of common stock.After these considerations, we should wonder whether the market value is currently offering a discounted price. Nowadays the answer is very uncertain, but as we have explained, it is very likely that the coronavirus effects have not been discounted in the stock prices. In addition, the results of the first quarter of 2020 have not been released yet. Together with the probable negative outcomes, the outlook for most of the companies and the recent downgrades given by the rating agencies, make reasonable to believe that the market is still expensive, probably more than before the outbreak of the coronavirus.

The equity market is not the only one that is suffering the crisis. The shock provoked by the coronavirus generated what the Financial Times has defined as “the seeds of the next debt crisis”. According to the Institute of International Finance[5], the ratio of total debt over Global Domestic Product reached 322% in the third quarter of 2019. During the last ten years, companies have gorged on cheap borrowings, but rating agencies’ estimations demonstrate how a global health crisis may push to an immediate reassessment of the credit risk, arising doubts about companies’ quality: stability and ability to generate cash flow in the short and medium-term. Also, in the debt market, the oil price war has led most of the oil and energy companies’ bonds to the distressed area[6].

Notwithstanding, financially speaking, every cloud has a silver lining. Indeed, this period will open the window to many M&A – Mergers and Acquisitions – opportunities. Discounted equity prices and a worsened debt structure may create occasions for companies with strong fundamentals. Solid companies with strong cash generation capacity may exploit the favorable environment to target businesses with a long-term positive outlook but with current solvency and liquidity problems.

Finally, the comprehension of gold price movements during the tumultuous period is of great importance. Gold is defined as a safe haven asset or defensive asset since it should outperform during recession periods and limit the downward pressure. Despite that, at the first glance, it seems that the metal has disappointed expectations. The recent sell-off has negatively characterized the gold performance which has undergone a contradictory result. However, the gold price changes are coherent with the history in periods of extreme volatility. It is very common that fund managers look for liquidity when markets are very volatile in order to fulfill margin calls of the riskiest assets. During the financial crisis in 2008, the gold price has decreased by almost 20% before climbing back to a value of 170% higher in 2011[7]. The gold price declined at the beginning because of liquidity restrictions, but, after the liquidity injection from central banks in the financial systems, it moved up in the traditional way. We can expect similar behavior in the forthcoming months.

Gold price path since 2007

Beyond any doubts, the coronavirus has highlighted how our lives are interconnected. The pandemic has caused a global lockdown and half of the world population is in quarantine. People are changing their lifestyle, changing how they work, socialize, play, talk and learn. The health crisis will inevitably influence economically and financially entire industries, affecting the world permanently. Some sectors, such as tourism, automotive, airlines, will suffer the most from the global instability, facing the hardest challenge. Despite that, nowadays, we are still not fully aware of the effects that the coronavirus will bring to the market but a substantial effect on both demand and supply are expected in the upcoming months. Thus, it is reasonable to forecast an additional discount on the market in the future.

written by Gianlorenzo Zeccolella

[1] https://www.investing.com/indices/volatility-s-p-500

[2] Futures are contracts which allow two counterparties to agree on exchanging a certain stock – or other financial asset – on a certain future date for a price fixed at the agreement date. The value of a future can be determined from the comparison between the strike price, fixed at the agreement, and the actual value on the market of the underlying asset at the settlement date. Future contracts are the main instruments traded for the oil

[3] https://www.rystadenergy.com

[4] https://www.eni.com/en-IT/media/press-release/2020/03/eni-covid-19-update-2020-2021-business-plan-revision.html

[5] https://www.iif.com

[6] Financial distress is a situation in which a firm is not able to meet its financial obligations. In these conditions, it might unable to payback its debt or just a portion of it.

[7] https://www.investing.com/commodities/gold

Saviour or traitor to the Fatherland? Tsipras, Europe and Greece after the political elections

Map of the cities founded by Ancient Greeks:
Fonte: My country? Europe

Zante. It is the first thing I remember of Greece, the island that in my imagination has always represented the most beautiful poetry of Italian literature, A Zakynthos, by Ugo Foscolo. The second, going a fragment ahead with the memory, are the endless expanses of olive groves that open from our bus. It’s the summer of 2009, I’m not even 18, and the first trip to the other Adriatic coast will be the first of a long series to discover the many fascinating places that Europe can offer. The guide, in his fifties, as well as a subtle indifference towards the Turks, introduces us to what is the temple of Greek civilization, where the first games, which later became the Olympics, were born. We are in Katakolon, a city in western Greece where a civilization is born, grows, and leaves many of its props in what is today’s society. Hellenia, Mediterranean culture, Europe. It is really a paradox that the same Olympic games of 2004, whose management – to use a euphemism – was not too clear [1] , were the spark that caused the economic crisis to explode, to then bear its bloodiest decade over a decade later.

Greece voted during this summer, and the political scenario was completely reversed compared to five years ago. The popular formation of Nea Dimokratia won the elections, reaching the threshold of absolute majority in Parliament, and relegating Syriza to the opposition after four years of government made of roller coasters and frontal clashes with the European Union.

There are many ideas that the Greek case can offer. After a summary of Greece’s relationship with the European Union in recent years, I will focus on two; the figure of Alexis Tsipras and his excellent political abilities, and how the Greek political system is structured following the political vicissitudes of the last decade.

Greece has experienced an era apart in recent years, constantly in the eye of the storm, with the default risk that has crossed it until it is on the verge of no return. But the problems of the Greek crisis have more distant roots, which sink in past decades. They have existed since the entry of Greece into the then European Community, born for political reasons, and it is paradoxical that its crisis was born exclusively for economic reasons [2] . After altering its accounts to enter the European Community in 1981 [3] , and still to be able to organize the 2004 Olympics, Greece has always had an uneasy relationship with the Union, exacerbated by the crisis of recent years.

In January 2015 Alexis Tsipras leads Syriza, an anti-capitalist leftist party, to a resounding success, touching the absolute majority of seats in Parliament (149 out of 300), and forming a Government with the Greek nationalists of ANEL highlighted its strategical capabilities. The scenario that Alexis faces is dramatic; the country is strangled by public debt, and is faced with its responsibilities by the austerity policies of the European Union. In this struggle between austerity and debt sustainability, Tsipras decides to hold a Referendum in which he asks whether to accept the agreement with Troijka, which provides for a debt recovery plan after implementing austerity policies. The Referendum was rejected in 2015 with over 60% of the votes. But the Union does not accept discounts, and threatens to kick Greece out of the eurozone if the pact is not accepted. Tsipras resigns, he goes to early elections, which once again reward Syriza who, again with the figure of Tsipras, will again form a government with ANEL. There is no way out. Tsipras finally decides to accept the austerity policies promoted by Brussels, disavowing a clear popular will. In the eyes of many it is an unprecedented reverse, a betrayal of the demos difficult to digest. And at this point I stop. Tsipras’ parable would open the doors to a debate as long as it is difficult to discern a univocal perspective; there are those who label him as a traitor to the homeland, as he who could have opened them leads them to a different type of leftist, rejecting the diktat of the Union and leading an alternative, and did not do so. As many, they welcome him as a wise, reasoned figure: one who, having experienced the complexity of a state and its objective responsibilities towards itself and towards the outside, has revised its positions in the most useful way to its country, to put him back on track, to give him sustainability, and to avoid a default that, among other things, Greece has definitely passed only a few months ago [4] .

Alexis Tsipras, leader of the extreme-left party Syriza

Whose responsibility was this crisis? Was it possible to manage it better? The austerity of the Union in wanting to submit Athens to its economic choices, or the negligence with which local politicians (who preceded Tsipras by a few decades) have faced expenses and tampered with public accounts, weighing everything on their citizens’ shoulders? Despite the attitude of Brussels towards Athens (although on the ways and attitudes there would be a lot to talk about) it was a strict but necessary plan to save the Hellenia from bankruptcy, but it also provided a formidable propaganda tool for all those Eurosceptic parties who oppose the Union and its policies. The image of a Union serving banks that puts at risk the lives of the European peoples in order to serve the interests of the power groups has now entered the collective imagination of all forces hostile to the Union, and to remove this label will not be simple at all.

You can choose the angle you want to observe the figure of Tsipras, of his widely disavowed values, and of his way of acting, pragmatic up to the unbelievable. The only thing that cannot be changed are the numbers: if so many observers foresaw a collapse of Syriza for these elections [5] , this was not the case. Despite highly unpopular moves, Tsipras remained standing, testifying to his exceptional political qualities. Syriza has lost so in the center, with moderate voters who have decided to move towards a political formation that gives them confidence and stability on the markets, but not on the left, where the PSOK remains distant the enormity of 20 percentage points. All this leads us to affirm that Syriza contained the defeat very well for 3 reasons: 1) it has recovered a million votes compared to the European Elections, and in general its result has gone well beyond the forecasts of all the research centers 2) It maintains the monopoly of the left electorate 3) It is proposed, if needed, as a possible government partner, given that the many souls that make up Nea demokratia leave more than a doubt about the stability of a single-color executive.

The Greek parliament after last elections:
Nea Dimokratia got the 39,85%, Syriza got the 31,53%.

Looking at the global, Syriza’s result pushes us to two other considerations. The first concerns the future of social democracy. What Syriza, the extreme left party, has given to PASOK, a party linked to the social democracy of the new millennium, is a historical lesson; they fell to around 10% of the vote and thus took the monopoly of the electorate of this area. From this overtaking “to the left” what derives from it? Can the electoral strategy of “extremization” of the left speech be replicated elsewhere with the same electoral results, or is Syriza’s unique situation facilitated by more circumstances? How much did Tsipras’ charisma and economic crisis affect his success? If we look elsewhere the only case where the left has outclassed social democracies and where it continues to have the pulse of that electorate is France with Mélechon (also a leader of extraordinary qualities). Elsewhere the Socialist Party, after a phase of decline, maintains the monopoly of the left world, as in Spain and Portugal. So does the strength of Syriza derive from the ability of the leader, from its contents or rather from the external context? A good question, to which only other empirical evidence will be able to provide more accurate answers.

On the other hand, the ideological barricades against extremist parties are more alarmingly confirmed, dictated more by a disproportionate fear of dissenting voices, than by the real consistency of phenomena destined for political marginality. The case of Golden Dawn, on which the media of half of Europe have focused, is the classic example. As the Greek elections have shown, the right-wing electorate prefers to merge votes on a more credible government alternative on all fronts, alias Nea Dimokratia, rather than on those who promote policy that is absolutely unworkable in today’s society. It is no coincidence that Golden Dawn has halved its votes compared to 2015, in favor of an ideologically moderate party that is actually more suited to dialogue with Europe and the markets. From the two points just taken, we derive a strong structuring of the Greek political system in a bipolar sense; a well-structured left-and-right alternative, which steals votes in the center, ready to capitalize on the mistakes of others, supported by other small parties that remain to watch, but which can always play a potential for government or blackmail [6] , like demonstrates Syriza’s alliance with ANEL in the past legislature, and how it could happen again.

What will be the future of Greece, the cradle of European civilization, is a puzzle that is difficult to solve. Difficult because the trust that the Greeks put in the Union is almost nothing, and given the disastrous turnout for the latest policies where one person out of two voted, it demonstrates precisely this dissatisfaction of the electorate 7] . Certainly, the clash with the Union has left bloody wounds at all levels, which only a generation of responsible politicians, we hope, will be able to heal.


Alessio Vagaggini

[1] On this topic: Il Sole 24 Ore, Le Olimpiadi in Grecia del 2004 furono l’inizio del default, Vittorio Da Rold, 14 Febbraio 201,  & Il Fatto Quotidiano, Quando Goldaman Sachs truccava i conti della Grecia per farla entrare nell’Euro, Leonardo Martinelli, 26 Marzo 2012.

[2] On how Geece entered in the European Community, please have a look at Limes, Tsipras, l’Europeista immaginario, Tra Euro e Neuro, n°7 – 2015.

[3] On these inconsistencies, one may observe, the European Community may have pretended not to see in order to ease the the access of Greece in the European Community and become part of the OTAN, with the scope of make it get far from Soviet Union’s influence

[4] Il corriere della sera, La Grecia esce dal programma di aiuti: addio alla Troika dopo 8 anni di crisi, Giuliana Ferraino, 19 Agosto 2018.

[5] The Guardian, Syriza betrayed its principles – and the Greek people. Its days are numbered, July the 5th 2019.

[6] According to Sartori’s definition, highlighting the importance of small parties on the decisions made by a given government. .

[7] Il Post, La crisi in Grecia spiegata in 12 grafici, 4 luglio 2015.


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