Below Zero

On 20 April 2020, oil did not merely become worth­less. For some con­tracts, getting rid of it became valu­able.

It is 2:30 in the after­noon in New York. The May con­tract for West Texas Intermediate crude on the New York Mercantile Exchange settles at minus $37.63 a barrel. On Friday it settled at $18.27. Today it has traded as low as minus $40.32. Tomorrow, its last day of trading, it will expire at $10.01. Right now, anyone holding a con­tract to receive a thou­sand barrels of oil in May can get out of it only by paying some­body else nearly $38,000 to take it.

The head­lines said the price of oil had gone neg­a­tive. That is almost right, and the part that is wrong is the whole story.

What the con­tract actu­ally was

Forget oil in general. A WTI futures con­tract is an agree­ment to take or make deliv­ery of a thou­sand barrels of a spe­cific grade, during a spe­cific month, at a spe­cific place: Cushing, Oklahoma, a town of tanks and pipe­lines where much of the crude in the middle of the United States passes through. Most people who trade the con­tract never intend to see the oil. They sell or roll their posi­tion before it expires. The ones still holding at expiry either have some­where to put a thou­sand barrels, or find some­body who does.

In April 2020 the world had stopped driving and flying. Demand col­lapsed faster than pro­duc­tion could be shut in, and the oil had to go some­where. Storage every­where was filling, and the market's fear was that the tanks at Cushing would be full by May. The US Commodity Futures Trading Commission's staff later described an over­sup­plied market, an unprece­dented fall in demand, and concern about the avail­abil­ity of storage, all arriv­ing at once on the day before expiry.

For a holder of the May con­tract with nowhere to store the oil, the cal­cu­la­tion on the after­noon of 20 April had stopped being what oil was worth. It had become what it would cost to avoid receiv­ing it. Past a certain point, paying a stranger to take the obli­ga­tion was the cheap­est option avail­able. The CFTC staff found the fastest part of the fall hap­pened between 1:00 pm and the 2:30 pm set­tle­ment.

It was never the price of oil

On the same after­noon, the June con­tract for the same grade at the same place traded above $20. Oil a month later was worth a pos­i­tive amount. Oil that had to be taken now, with no tank to put it in, was worth less than nothing. Same crude, same town. What dif­fered was time, place and a tank: the three things the word price usually hides.

The minus sign was a truth­ful report of a phys­i­cal problem. The barrels had not lost their energy content. What had gone neg­a­tive was the right to receive them at a moment when receiv­ing them was a lia­bil­ity. A futures price describes a con­tract, and a con­tract describes an obli­ga­tion, and an obli­ga­tion can be worth avoid­ing.

Other ways below zero

Electricity goes below zero rou­tinely now. Germany recorded 457 hours of neg­a­tive whole­sale prices in 2024, up from 301 in 2023, accord­ing to its Federal Network Agency, mostly around midday in summer when solar output peaks. Power cannot be stored cheaply at scale. Some plants are expen­sive to switch off and on again, and some gen­er­a­tors are paid for output under support schemes regard­less of the market price. At those hours, paying some­body to consume a megawatt-hour is cheaper than the alter­na­tives, and the price says so.

Negative inter­est rates look similar and work dif­fer­ently. The European Central Bank set its deposit rate below zero in June 2014 and kept it there until July 2022. The Bank of Japan's policy rate was neg­a­tive from 2016 until March 2024. Those were admin­is­tered rates, chosen by central banks as policy, and what they priced was the cost of holding money at the central bank. They are rel­a­tives of the oil episode, cousins rather than twins, and it would be sloppy to call them the same mech­a­nism.

The systems that assumed zero

A good deal of finan­cial soft­ware had been written on the assump­tion that prices cannot fall below zero. It is a natural assump­tion for shares, which have limited lia­bil­ity, and for most phys­i­cal goods most of the time. Order entry systems rejected neg­a­tive numbers. Risk models took log­a­rithms of prices, which do not exist for neg­a­tive values. Option pricing models used by exchanges assumed that prices are always pos­i­tive.

In the days before 20 April 2020, CME Group told market par­tic­i­pants that its systems could handle neg­a­tive prices in energy futures and options, and after the event it switched the model it used to value some energy options to one that allows prices below zero. Brokers and plat­forms that had not pre­pared found their own systems unable to display, margin or close posi­tions at the prices the exchange was print­ing.

Funds that held the front-month con­tract had a struc­tural version of the same problem. An exchange-traded oil fund that owns near-dated futures must sell them before deliv­ery and buy later ones. When the near con­tract col­lapses rel­a­tive to the next, that roll is expen­sive, and after April 2020 the largest US oil fund moved its hold­ings spread across later months. The minus sign did not only change a price. It changed which prices people were willing to hold.

What the minus sign teaches

It is tempt­ing to treat April 2020 as the day a market went mad. It is more useful as the day a market was unusu­ally honest. Most of the time a price quietly blends the value of a thing with the cost of holding it, moving it and waiting for it, and those costs are small enough to ignore. That after­noon the costs were larger than the thing.

Once a price can fall below zero, the idea of intrin­sic worth has to go. What is left is what some­body would give, under con­straints, to be on one side of a con­tract.