skip to Main Content
enquiries@thearmchairtrader.com

Sign up for our Free Daily Digest newsletter: Actionable insight every morning, designed for the self-directed investor. Find out more

It would almost be an understatement to call yesterday’s plunge in oil prices an oil shock, the one-day decline was so big that most traders needed time to wrap their heads round the idea of negative oil prices.

But the spectacular decline is just temporary – it was caused by the Tuesday expiry of the May WTI contract and though the plunge has sent a negative message about the state of the near term oil market, below zero oil is not the kind of price that we will be seeing regularly going forward, at least not on dates other than pre-expiry dates.

Crude is trading in a more realistic territory this morning with Brent at $22.50 and WTI at around $20, close to March low.

What you need to know about the current oil price

A few things need to be considered. First this only related to the May contract which was about to expire and had become very illiquid as major trading desks had given up on it several days prior. CME Group data indicated volume of 122k for May contract vs 780k for June. Two, the June contract remained much firmer, albeit it too was dragged lower towards $20.

You also need to bear in mind that Nymex WTI is a physical contract – if you hold it to expiration you need to take delivery. Normally as you approach expiration of a futures contract, traders simply roll their positions over to the next month without any fuss. What we saw yesterday was very much a roll over problem – traders holding the May contract couldn’t find any buyers because no one with the ability to take delivery wanted it. This is because of the collapse in physical demand for crude products like petrol and jet fuel, which means the storage capacity at hubs like Cushing, Oklahoma is near to ‘tank tops’.

So, what we got was a severe dislocation as paper traders found they had to offload positions without any liquidity or bid in the market. A unique event, but one that reflects how financial markets can become very dysfunctional very quickly when things go bad.

What was the impact on oil stocks?

And whilst it wasn’t a good day for the oil majors, Chevron and Exxon Mobil fell around 4%, hardly the meltdown suggested by the front month implosion. The kind of dislocation witnessed yesterday, however much some may downplay it, does point to a fundamental problem in oil markets, namely a lack of storage capacity and demand. But it also shows the market trying to do its job, forcing the price down enough to shut production. The problem is closing down production sites is not that easy and not cheap, so producers are desperately trying to avoid it.

“Donald Trump says he will add 75m barrels to the US SPR – always one for a deal. OPEC is said to be looking at cutting oil output immediately, rather than waiting until next month,” said Neil Wilson, Chief Markets Analyst at Markets.com “You should also note that Brent is much more stable, albeit still pressured to the downside, as OPEC+ cuts are due to take effect and storage constraints are less pronounced.”

WTI – for June – was down testing the $20. It’s hard to see how it can hold up against the immense pressure from the lack of storage.

It’s all about the storage

Looking at a generic front month WTI price chart, one could be tempted to think that you could make close to $60/bbl out of thin air once we shift to the June contract. But you cannot, unless you have lots of physical storage space to hold the oil delivered for a month.

The reason for the negative price yesterday was because oil storage is getting very tight. People are actually being paid to take the oil and store it. The expiring contract will deliver the oil between May 1st and May 31st, so those who are long the contract and are taking physical delivery need somewhere to store it. Equally those, who were holding the May 2020 contract, would most likely have rolled out the contract before yesterday’s big price moves, saving themselves from big losses.

“Coronavirus is rewriting the rules of the global economy in front of our very eyes,” commented Adam Vettese at CFD broker eToro this morning. “With oil demand virtually non-existent, this quite amazing sell-off is almost entirely down to fears over storage. It’s worth noting that Brent, the other major oil type, does not have the same storage issues as US crude, meaning the oil producers with the biggest US exposures will be hit the hardest.”

The reaction of Asian markets overnight shows how this has spooked investors and it’s clear now that OPEC+ will have to agree further cuts in order to boost oil prices. In the meantime, this has caused yet another headache for governments and central bankers, who are desperately trying to contain the economic fallout of Covid-19.

Such a sharp plunge in the price of oil could cause a rapid slowdown in global inflation and some countries may even suffer deflation off the back of this. It’s a headache that central bankers and governments don’t need at this time as they try to keep their economies afloat during the crisis.

Share this article

Sign up to our Daily Digest newsletter and receive our latest insight every morning

Please note this article does not constitute investment advice. Investors are encouraged to do their own research beforehand or consult a professional advisor.

Stuart Fieldhouse

Stuart Fieldhouse

Stuart Fieldhouse has spent 25 years in journalism and marketing, including as a wealth management editor for the Financial Times group, covering capital markets and international private banking, and as an investment banking correspondent for Euromoney in Hong Kong. He was the founder editor of The Hedge Fund Journal.

Stuart has worked at CMC Markets, supporting the re-launch of its global financial spread betting and CFD trading platforms. He is also the author of two books on trading, published by Financial Times Pearson. Based in The Armchair Trader’s London office, Stuart continues to advise fund managers, private banks, family offices and other financial institutions.

Comments

This Post Has 0 Comments

Leave a Reply

Your email address will not be published.

Back To Top