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No Free Lunch

Giveaway oil, giveaway loans?

Something strange happened last week. For the first time in history, crude oil actually traded at nearly -$40 per barrel. Yes, negative $40! That means that oil sellers actually paid someone to take a barrel (about 42 gallons, or 159 liters) of crude oil off their hands. And did you know that some central banks had already adopted a negative interest rate policy, meaning, you’d have to pay your bank to hold your deposits, rather than earn interest from the money you effectively lent them? With the world seeing negative oil prices and negative interest rates, we must be in rather unusual times — and indeed we are.

Before anyone gets ideas about ordering tanker loads of free oil and stockpiling it, or running to the bank hoping to get paid to borrow money, let’s understand better what these negative oil prices and interest rates really mean. As for oil, what happened was last April 20, sellers trading in the US commodities market (the New York Mercantile Exchange) who were holding contracts for May delivery of American oil (West Texas Intermediate crude) actually paid buyers up to $38.45 per barrel just to accept it. Why was oil yet to be received next month such a hot potato that no one wanted it, even for free? The reason was that there’s just too much oil around that is not being used due to the standstill caused by lockdowns in the United States and most everywhere else in the world. Meanwhile, facilities to store more oil are running out. It’s an extreme case of the law of supply and demand at work: With too much supply and greatly reduced demand, prices would have to drop for the market to clear — in this case even well below zero. But why negative? Anyone holding those May oil contracts would have a big problem in their hands. Not only would there be no buyers when they get the oil next month; they will also have nowhere to store it — or will have great difficulty, and incur unusually higher costs, to do so. Thus, they had to be paid to actually accept it.

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Could it have made sense for a Philippines-based oil industry player to “buy” that negative-priced oil? It would have been a complicated proposition. First, the delivery point for US oil contracts is Cushing, Oklahoma, a small southern town that is a vital oil transshipment point where numerous refiners, suppliers, storage facilities, and oil pipelines converge — so transport from there must be reckoned with. There’s a good reason why the bulk (86 percent) of Philippine crude oil imports come from the Middle East, and nearly all the rest (12 percent) from nearby South Korea, Malaysia, and China. Too bad for us, such negative prices have not happened for Dubai crude, which is the benchmark price for the oil we buy. Second, contracts are in units of 1,000 barrels, with most oil trades done for many times that volume — but we probably don’t have that much storage space to spare either.

Meanwhile, negative interest rates had already been resorted to by Sweden, Japan, Switzerland, Denmark, and the European Central Bank even since the 2009 financial crisis. What this really means is that banks must pay their central bank to keep their excess reserves there, rather than receive interest income, as is usual. In turn, the banks would charge depositors a “storage fee” for keeping their money, rather than pay them interest for it. Central banks of economies in stagnation or recession have resorted to this move, especially when prevailing interest rates are already at or close to zero. It makes it costlier for people to save their money rather than spend it, and for banks to keep money idle than lend it, thereby pushing consumers and businesses to spend more, thus stimulating the economy. But don’t expect banks to actually pay people to get a loan, meaning, get back less than what was borrowed. Banks do have to make money.

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All told, we’re now in a very different era of unprecedented negatives, all because of a microscopic enemy that has invaded our world. There must be some silver lining here; after all, we should be seeing much lower petroleum prices soon. But until we all feel safe moving around freely again, it’s like getting a pretty cake in a locked glass case.

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TAGS: Cielito F. Habito, negative interest rates, negative oil prices, No Free Lunch
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