Minus prices are not uncommon, even if they suggest infinite losses and generate horror
Robin Harding
Rover workers demonstrate in 2000. When BMW sold the British car company, it had to provide a ‘dowry’ of hundreds of millions of pounds to reflect the dire state of the business © Gerry Penny/AFP/Getty
There are not many things you have to pay to get rid of: hair, rodents, industrial waste, teenage children and, as of this week, crude oil.
On Monday, the price of West Texas Intermediate for delivery in the month of May fell as low as minus $40.32 a barrel, becoming negative for the first time in history. People have schemed, starved and even gone to war to get oil.
But this week, even if only briefly, they would have paid you to take it off their hands.Crude oil’s dramatic price fall shows the depth of the current plunge in demand and sheds light on the curious phenomenon of negative prices.
These are actually fairly common — occurring everywhere from electricity markets to stock exchanges that pay for order flow to boost liquidity — but they are unsettling, because they seem to upset the natural order of things. Surely an item of such obvious cost and utility as oil must always be worth something?
Human beings are prone to the cognitive bias of loss aversion, putting more weight on a loss than an equivalent gain. It is not surprising, therefore, that we feel a certain horror at negative prices.
They suggest your assets can turn to liabilities, losing you everything and more. That distaste shows itself most strongly in the widespread anger across Europe and Japan at negative interest rates — the world’s most prominent negative price and likely to continue for years to come.
The obvious question posed by negative prices is why trade occurs at all if the price is less than zero. Why not hold on to what you have? There are at least three different reasons.
The first is a storage problem familiar to anybody clearing a house for sale. The grand piano may be beautiful, but if there is going to be nowhere to put it, it turns from an asset into a liability as the day of the move draws near.
US oil traders found themselves in a similar position this week. Owning a barrel of WTI at contract expiry means taking physical delivery in Cushing, Oklahoma. You cannot keep crude oil in the attic.
So if oil storage tanks are full, you have a serious problem.
A similar thing happens in electricity markets. Electricity is notoriously hard to store, but shutting down a coal or nuclear plant is costly and time consuming. So when supply exceeds demand, it can make sense to pay users to take it.
This situation is occurring more often as solar and wind, which have minimal operating costs and generate power as long as the sun shines and the wind blows, join electricity grids. It can also occur if there are subsidised suppliers, who make money at a negative price if the subsidy is more.
A second reason for negative prices is when there is a liability attached to an asset.
Contaminated land may cost less than nothing because of the expense of cleaning it up. When BMW sold the British car company Rover in 2000, it provided a “dowry” of hundreds of millions of pounds to reflect the dire state of the business.
Likewise, unless waste can be recycled at a profit, it has a negative price because of the disposal cost.A third scenario is when something appears to have a negative price but the buyer is actually providing the seller with something of value.
For example, a bike-sharing network may pay its customers if they ride its bikes from the suburbs back to the centre of the city, where they may be needed more. Stock exchanges may pay retail brokers for the privilege of executing their orders, because such orders are of value to other customers, such as market makers who can profit by trading with it.
Interest rates can also go negative because of the storage problem. Buying a safe costs money, there is still a risk of theft and, furthermore, large payments with cash are cumbersome. So paying for storage in a bank deposit can make sense.
The economist Kenneth Rogoff of Harvard has suggested the abolition of high-denomination notes, removing them as a storage option, which would allow for deeper negative rates as a tool to stimulate activity in the economy. This idea has not proved popular.
The mechanics of negative prices are straightforward enough. But what they cannot explain is why a barrel of oil or a cash deposit would become of so little value that the cost of storage is relevant.
In the case of oil this week, the answer is clear: demand has collapsed because of the coronavirus pandemic. So storage, either by leaving oil in the ground or pumping it into a supertanker, is the only option.
Something similar has happened to interest rates, which balance the supply of savings with demand for investment.
In an ageing, slow-growth world, the supply of risk-free deposits is high but the demand to borrow them is not, so the price is often negative.
That feels wrong and prompts a great deal of anger at central banks.
As the world struggles with the coronavirus downturn, it is not only oil traders who will feel the pain of negative prices.
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