Negative pricing

Last updated November 04, 2024

In economics, negative pricing can occur when demand for a product drops or supply increases to an extent that owners or suppliers are prepared to pay others to accept it, in effect setting the price to a negative number. This can happen because it costs money to transport, store, and dispose of a product even when there is little demand to buy it, or because halting production would be more expensive than selling at a negative price.^[2]

Negative prices are usual for waste such as garbage and nuclear waste. For example, a nuclear power plant may "sell" radioactive waste to a processing facility for a negative price; in other words, the power plant is paying the processing facility to take the unwanted radioactive waste.^[3] The phenomenon can also occur in energy prices, including electricity prices,^[3]^[4] natural gas prices,^[5] and oil prices.^[6]^[7]

Examples

Natural gas in West Texas

Natural gas prices in the Permian Basin, West Texas, went below zero more than once in 2019. Natural gas is produced there as a byproduct of oil production, but production has increased faster than the construction of pipelines to transport natural gas. Oil production in the Permian Basin is profitable, so the natural gas continues to be produced, but disposing of it is costly: producers must burn the gas (which is subject to regulations) or pay for space on existing pipelines. As a result, the price of natural gas becomes negative; in effect, producers of natural gas pay others to take it away.^[5]

Oil in 2020

In March and April 2020, demand for crude oil dropped dramatically as a result of travel restrictions related to the COVID-19 pandemic.^[8] Meanwhile, an oil price war developed between Russia and Saudi Arabia, and both countries increased production.^[7] The exceptionally large gap between supply and demand for oil began to strain available oil storage capacity.^[8]^[7] In some cases, oil storage and transportation costs became higher than the value of the oil, leading to negative oil prices in certain locations, and, on one day (20 April 2020), negative prices for oil futures (contracts for oil to be delivered at a future date).^[6]^[9]^[10] West Texas Intermediate (WTI) futures went as low as −$37.63 per barrel^[11] (though consumer prices did not go negative). In effect, with demand low and storage at a premium, oil producers were paying to get rid of their oil.^[6]^[9]^[11]

MarketWatch described the situation as "the opposite of so-called short squeeze." In a short squeeze, investors who are short an asset must cover their positions as the price goes up, leading to a vicious cycle as prices continue to rise. With oil prices in 2020, traders with long oil positions needed to cover their positions for fear of finding themselves with oil and nowhere to store it. According to MarketWatch's analysis, the rapid drop in oil futures prices may have been an artifact of the structure of the futures market rather than an accurate reflection of the supply and demand for oil.^[9] Negative oil prices "meant the discovery of a new market condition ... an 'oil Everest, but in reverse.' Oil prices not only hit rock bottom, but they also broke the rock."^[12] However, prices recovered to pre–COVID-19 levels, and the glut of oil has disappeared.

A trial for market manipulation is ongoing against Vega Capital London Ltd a group of nine independent traders at Essex who would buy oil futures with the expectation to win if the price went down at the end of the contract but are accused of doing so by deliberately buying big volumes and coordinating their activities to artificially push down the price, is estimated that on 20 April they traded more than BP, Glencore, and JPMorgan Chase at around 29.2% of the total volume in WTI crude oil futures and that their trades were correlated between 96.2% and 99.7%,^[13]^[14]^[15] as prices went negative at the end of settlement in fact they would win money too so is estimated that in total they made around $660 million on just a few hours. The trial anticipated to last at least until 2025.^[16]

Electricity

When demand for electricity is low but production is high, electricity prices can go negative. This can happen if demand is unexpectedly low (for instance, because of warm weather) and if production is unexpectedly high (for instance, because of unusually windy weather).^[17] In 2009 alone, the Canadian province of Ontario experienced 280 hours of negative electricity prices,^[18] and in 2017, German power prices went negative more than 100 times.^[17]

Negative electricity prices happen as a result of uneven and unpredictable patterns of supply and demand: demand is lower at certain times of day and on holidays and weekends, while wind and solar production are highly dependent on weather.^[17] When excess supply causes electricity prices to fall, some producers, including wind and solar, may cut production. But for some coal and nuclear power plants, stopping and starting production is costly (the xenon pit may also preclude quickly restarting a reactor after a certain period of shutdown^[19]^[20]), so they are more likely to continue production even if prices become negative and they must pay to offload the energy they are producing.^[21]^[17]^[22] Moreover, for wind and solar, renewable energy subsidies in some markets can more than offset the cost of selling power at negative prices, leading them to continue production even when the price drops below zero.^[22] Possible methods for avoiding/reducing negative electricity prices involve improving technology and expanding capacity to store excess power for later use (e.g., pumped hydro storage, thermal energy storage), distributing electricity more widely along a super grid, demand response, and better predicting surges in supply.^[17]

This phenomenon occurs in wholesale electricity prices,^[21] and it is possible for businesses to earn money or receive credits for using electricity at times of negative pricing.^[17]^[23] However, while residential electricity consumers may also save money on electricity when wholesale prices go negative, they generally do not experience negative prices because their electricity bills also include various taxes and fees.^[17]^[21]

In certain markets, financial incentives for the production of renewable energy can more than offset the cost of selling power at a negative price.^[22] In the United States, these incentives are found in the federal renewable electricity production tax credit (PTC) program and through the trading of renewable energy credits (RECs). Eligible generators that opt into the PTC program receive a tax credit for each kilowatt-hour (kWh) of electricity produced, over a period of 10 years for most types of generation. In 2020, this payment ranged from $0.013/kWh to $0.025/kWh, varying based on the type of generation.^[24] The avoided tax from the receipt of a production tax credit can more than offset the cost of dispatching electricity at a negative price.^[22]^[24]^[25] Separate from tax credits are RECs (in the United States) or green certificates (in Europe), tradeable instruments that represent the environmental benefits of renewable generation.^[26]^[27]^[28] These instruments can be sold and traded, allowing generators to offset negative power prices.^[29]

In Texas, a large buildout of wind energy has driven negative pricing in ERCOT, the state's electrical grid operator.^[30]^[31] From January 2018 through early November 2020, pricing in ERCOT was negative in 19% of hours.^[31] The high frequency of negative electricity pricing in Texas is driven by the high penetration of wind relative to other states – nearly three times that of the next state as of mid-2019^[32] – and ERCOT's isolation as a separate transmission system with limited interconnection into other parts of the United States, limiting ERCOT's ability to transmit excess power to other parts of the country.^[33]^[30]

Onions in 1956

In the United States in 1956, commodities traders Sam Siegel and Vincent Kosuga bought up large quantities of onions and then flooded the market as part of a scheme to make money on a short position in onion futures.^[34] This sent the price of a 50-pound bag of onions down to only 10 cents, less than the value of the empty bag.^[34]^[35] Effectively, the price of the onions was negative.^[36]

Installment receipts

It is possible for installment receipts to trade at negative prices. An installment receipt is a financial instrument for which the buyer makes an initial payment and is obligated to make a second payment later on, in exchange for ownership of a share of stock.^[37]^[38]

In 1998, investors in Canada bought installment receipts for shares of Boliden Ltd. Investors made an initial payment of CA$8 per share for the receipts, which obligated them to make a second $8 payment later on. But when the share price dropped to $7.80, the value of a receipt became negative: a receipt obligated its holder to make an $8 payment for a share worth less than $8. As a result, the receipts traded at negative values ranging from −$0.15 to −$0.40, and their trading was suspended on the Toronto Stock Exchange.^[39]

Effects

Typically, negative prices are a signal that supply is too high relative to demand. They can lead suppliers to cut production, bringing supply more in line with demand.^[40]^[41]

Challenges

Electronic trading systems may not be set up to handle negative prices. If negative prices are a possibility, market participants must verify that their systems can process them correctly. This includes pricing models, market data feeds, risk management, monitoring for unauthorized trading, reporting, and accounting.^[42]

Derivatives traders traditionally rely on models, like the Black–Scholes model, that assume positive prices. In a situation where products have negative prices, these models can break down.^[43]^[44] As a result, in April 2020 amid the collapse in oil prices, the CME Group clearinghouse switched to the Bachelier model for pricing options in order to account for negative futures prices.^[44]^[45]

Related Research Articles

The Electric Reliability Council of Texas, Inc. (ERCOT) is an American organization that operates Texas's electrical grid, the Texas Interconnection, which supplies power to more than 25 million Texas customers and represents 90 percent of the state's electric load. ERCOT is the first independent system operator (ISO) in the United States. ERCOT works with the Texas Reliability Entity (TRE), one of six regional entities within the North American Electric Reliability Corporation (NERC) that coordinate to improve reliability of the bulk power grid.

<span class="mw-page-title-main">Texas Interconnection</span> Power grid providing power to most of Texas

The Texas Interconnection is an alternating current (AC) power grid – a wide area synchronous grid – that covers most of the state of Texas. The grid is managed by the Electric Reliability Council of Texas (ERCOT).

Natural gas prices, as with other commodity prices, are mainly driven by supply and demand fundamentals. However, natural gas prices may also be linked to the price of crude oil and petroleum products, especially in continental Europe. Natural gas prices in the US had historically followed oil prices, but in the recent years, it has decoupled from oil and is now trending somewhat with coal prices.

Energy in the United Kingdom came mostly from fossil fuels in 2021. Total energy consumption in the United Kingdom was 142.0 million tonnes of oil equivalent in 2019. In 2014, the UK had an energy consumption per capita of 2.78 tonnes of oil equivalent compared to a world average of 1.92 tonnes of oil equivalent. Demand for electricity in 2023 was 29.6 GW on average, supplied through 235 TWh of UK-based generation and 24 TWh of energy imports.

The energy policy of the United Kingdom refers to the United Kingdom's efforts towards reducing energy intensity, reducing energy poverty, and maintaining energy supply reliability. The United Kingdom has had success in this, though energy intensity remains high. There is an ambitious goal to reduce carbon dioxide emissions in future years, but it is unclear whether the programmes in place are sufficient to achieve this objective. Regarding energy self-sufficiency, UK policy does not address this issue, other than to concede historic energy security is currently ceasing to exist.

The energy policy of Australia is subject to the regulatory and fiscal influence of all three levels of government in Australia, although only the State and Federal levels determine policy for primary industries such as coal. Federal policies for energy in Australia continue to support the coal mining and natural gas industries through subsidies for fossil fuel use and production. Australia is the 10th most coal-dependent country in the world. Coal and natural gas, along with oil-based products, are currently the primary sources of Australian energy usage and the coal industry produces over 30% of Australia's total greenhouse gas emissions. In 2018 Australia was the 8th highest emitter of greenhouse gases per capita in the world.

Wind power in Texas, a portion of total energy in Texas, consists of over 150 wind farms, which together have a total nameplate capacity of over 30,000 MW. If Texas were a country, it would rank fifth in the world; the installed wind capacity in Texas exceeds installed wind capacity in all countries but China, the United States, Germany and India. Texas produces the most wind power of any U.S. state. According to the Electric Reliability Council of Texas (ERCOT), wind power accounted for at least 15.7% of the electricity generated in Texas during 2017, as wind was 17.4% of electricity generated in ERCOT, which manages 90% of Texas's power. ERCOT set a new wind output record of nearly 19.7 GW at 7:19 pm Central Standard Time on Monday, January 21, 2019.

The Energy in Russia is an area of the national economy, science, and technology of the Russian Federation, encompassing energy resources, production, transmission, transformation, accumulation, distribution, and consumption of various types of energy.

Energy in Australia is the production in Australia of energy and electricity, for consumption or export. Energy policy of Australia describes the politics of Australia as it relates to energy.

Different methods of electricity generation can incur a variety of different costs, which can be divided into three general categories: 1) wholesale costs, or all costs paid by utilities associated with acquiring and distributing electricity to consumers, 2) retail costs paid by consumers, and 3) external costs, or externalities, imposed on society.

Energy in Austria describes energy and electricity production, consumption and import in Austria. Austria is very reliant on hydro as an energy source, supported by imported oil and natural gas supplies. It is planned by 2030 to become 100% electricity supplied by renewable sources, primarily hydro, wind and solar.

The National Grid covers most of mainland Great Britain and several of the surrounding islands, and there are interconnectors to Northern Ireland and to other European countries. Power is supplied to consumers at 230 volts AC with a frequency of 50 Hz. In 2023 about a third of electricity used in Britain was generated from fossil gas and two-thirds was low-carbon power. Wind generates the most low-carbon power, followed by nuclear some of which is imported from France. The government is aiming for greenhouse gas emissions from electricity in Britain to be net zero by 2035.

In 2019, the total energy production in Indonesia is 450.79 million tonnes of oil equivalent, with a total primary energy supply of 231.14 million tonnes of oil equivalent and electricity final consumption of 263.32 terawatt-hours. From 2000 to 2021, Indonesia's total energy supply increased by nearly 60%.

Energy in Sweden is characterized by relatively high per capita production and consumption, and a reliance on imports for fossil fuel supplies.

Energy in Ukraine is mainly from gas and nuclear, followed by oil and coal. Ukraine has a diversified energy mix, and no fuel takes up more than a third of the country’s energy sources. The coal industry has been disrupted by conflict. Most gas and oil is imported, but since 2015 energy policy has prioritised diversifying energy supply.

Energy consumption per person in Turkey is similar to the world average, and over 85 per cent is from fossil fuels. From 1990 to 2017 annual primary energy supply tripled, but then remained constant to 2019. In 2019, Turkey's primary energy supply included around 30 per cent oil, 30 per cent coal, and 25 per cent gas. These fossil fuels contribute to Turkey's air pollution and its above average greenhouse gas emissions. Turkey mines its own lignite but imports three-quarters of its energy, including half the coal and almost all the oil and gas it requires, and its energy policy prioritises reducing imports.

Ireland is a net energy importer. Ireland's import dependency decreased to 85% in 2014. The cost of all energy imports to Ireland was approximately €5.7 billion, down from €6.5 billion (revised) in 2013 due mainly to falling oil and, to a lesser extent, gas import prices. Consumption of all fuels fell in 2014 with the exception of peat, renewables and non-renewable wastes.

Turkey uses more electricity per person than the global average, but less than the European average, with demand peaking in summer due to air conditioning. Most electricity is generated from coal, gas and hydropower, with hydroelectricity from the east transmitted to big cities in the west. Electricity prices are state-controlled, but wholesale prices are heavily influenced by the cost of imported gas.

Energy is a major component of the economy of Texas. The state is the nation's largest energy producer, producing twice as much energy as Florida, the state with the second-highest production. It is also the national leader in wind power generation, comprising about 28% of national wind powered electrical production in 2019. Wind power surpassed nuclear power production in the state in 2014. Since 2003, Texas state officials have created various initiatives like the Texas Enterprise Fund and the Texas Emerging Technology Fund to develop the economy of Texas.

World energy supply and consumption refers to the global supply of energy resources and its consumption. The system of global energy supply consists of the energy development, refinement, and trade of energy. Energy supplies may exist in various forms such as raw resources or more processed and refined forms of energy. The raw energy resources include for example coal, unprocessed oil & gas, uranium. In comparison, the refined forms of energy include for example refined oil that becomes fuel and electricity. Energy resources may be used in various different ways, depending on the specific resource, and intended end use. Energy production and consumption play a significant role in the global economy. It is needed in industry and global transportation. The total energy supply chain, from production to final consumption, involves many activities that cause a loss of useful energy.

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