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24 April 2020

Oil Plunges into Negative Territory

James Rowbury, Investment Research Coordinator

UK markets have remained relatively flat over the past week as investors are seemingly brushing aside economic data and volatility in oil prices and instead focusing on the potential reopening of economies and ongoing stimulus announcements from governments and central banks.

Global information provider IHS Markit released a report showing that business activity in the UK has fallen at the fastest pace ever recorded, with the composite flash Purchasing Managers’ Index (PMI) falling to 12.9 in April, compared to 36 in March. A figure above 50 indicates expansions while below 50 indicates contraction. These readings paint a stark picture of the impact of a paused UK economy as the lockdown takes hold on activity.

In another sign of a slowing economy, the Office for National Statistics reported that consumer price inflation had fallen from 1.7% in February to 1.5% in March. It is expected that the rate of inflation will continue to deviate from the Bank of England’s target of 2%; the recorded data only accounted for the period prior to the UK lockdown on 23rd March.

Investors, however, do not appear to have wavered after being presented with such negative data, perhaps suggesting that they now look to the third quarter for more visibility on the country’s economic recovery and the longer-term impact to corporate earnings. The Cboe UK 100 has increased 0.51% over the past week, as investors reacted to the news.

Conversely, US oil prices experienced their most volatile day on record on 20th April, as the West Texas Intermediate – a benchmark in oil prices – was trading in negative territory: -US$37.63 per barrel. While the figure was alarming, it is in some way unsurprising. The flash crash in oil prices was a direct result of the complex nature of financial derivatives in the commodity.

Commodity traders who held contracts with a May expiry started closing out these contracts to avoid taking physical delivery – a standard practice in the market. However, with global demand at such a low, the usual participants were unwilling to take the contracts off traders’ hands, as storage reached capacity.

The result? Buyers demanded payment to offset additional storage costs, and thus, unable to take delivery, traders were footing the bill to get it off their hands. While there have been instances of oil prices going below zero in other countries, a fall of such scale is unprecedented and markets around the world fell the next day as a result.

The US Senate approved a stimulus package of c.US$500bn for small businesses and hospitals ravaged by the Covid-19 pandemic. The deal includes US$320bn for small businesses and US$100bn for healthcare, which is split to US$75bn for hospitals and US$25bn for coronavirus testing.

Additionally, Germany put measures in place to reopen its economy, including allowing stores smaller than 800 square feet to reopen from next week. Despite these measures, the US S&P 500 has lost 1.6%, Hong Kong’s Hang Seng has shed 1.8% and Japan’s Nikkei 225 has fallen 2.38%.
Oil Plunges into Negative Territory
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