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Are these negative oil prices a signal to an Armageddon-style crash?

Peter Switzer
21 April 2020

If ever you needed a lesson on not investing in anything you don’t understand, then this collapse of the oil price into negative territory is a classic case in point. This money-making (or avoiding losing money) lesson, that is this crazy oil story, raises two critically important questions.

First, how does the oil price go negative? And second, what caused this?

On a negative oil price, don’t think the guy at the service station will be paying you to take his petrol. That’s never going to happen in my lifetime! The actual price of oil remains positive but it’s the futures oil price that has plunged well below zero.

This is how CommSec’s Ryan Felsman reported the story today. “US crude oil futures turned negative on Monday for the first time in history, ending the day at minus US$37.63 a barrel, as traders sold crude heavily due to rapidly filling storage space at the key Cushing, Oklahoma hub,” he wrote. “The May contract is due to expire on Tuesday. Brent crude - the global benchmark - fell by US$2.51 or 8.9% to US$25.57 a barrel.”

This last price is the real world price. But in the unreal world of future markets, Ryan says “the May US Nymex price plunged by US$55.90 or 306% to -US$37.63 a barrel. The June US Nymex contract - traded more actively - settled at a much higher level of US$20.43 a barrel, but was still down by 18%.”

This tells us that the market now thinks the oil situation will be chaotic in May but get better in June, as the May Nymex contract price is minus $US37.63, while the June price is plus $US20.43.

OK, I get it. You probably don’t get it because you’re a normal person, so let me keep this explanation simple. There are speculators who’d buy a contract for oil and they’d typically lock in a price that they’re willing to pay. When the contract expires, if the price is higher, they make a nice profit. This isn’t investing — it’s gambling. But the oil futures market has a quirky side to it because when the contract expires, if you can’t unload it to someone else, you have to accept delivery and then store it somewhere.

And that’s the problem that the Coronavirus has created — the world’s running out of storage space! You see, no one expected the world’s demand for oil would fall by over 30%, during what looks like a three-month period of lockdowns and restrictions on people’s movements.

Apart from the huge silo-like tanks that store oil around the world, oil tankers are even being used as floating warehouses for oil. Seriously, the place to store this stuff is becoming as scarce as hen’s teeth. “There is still a lot of crude on the water right now that is going to refineries that do not need it,” Helima Croft, global head of commodities strategy at RBC Capital, said Monday on CNBC. “Right now we don’t see any near-term relief for this oil market … we remain really concerned for the outlook on oil near-term.”

Oil price speculators, who like to call themselves traders, have nowhere to store the damn stuff so they’re prepared to exit their trading positions at virtually giveaway prices.

This is another Coronavirus curve ball and adds to the pressure on governments to look at how they wind back their lockdowns and closures of their economies. The only plus I can see from this left-field oil market development is that it didn’t lead to an overreaction in the stock market.

The S&P 500 Index, which tracks the top 500 companies in the USA, only dropped 1.79% (or 51 points), which means key market players are looking forward to what’s likely to happen to oil prices rather than what happened in the ‘casino’ that provides oil futures contracts for punters.

With European governments progressively and gradually opening their economies for business, the demand for oil will rise and these storage problems will disappear. And yes, the oil price will eventually rise but this is another example of how interdependent we all are and how closing down economies is a big deal.

And anyone who has gambled with oil exchange-traded funds (or ETFs) might find that their investment product didn’t buy shares in oil companies but was a play on oil futures contracts. If that’s so, you could have lost a lot of money. It reminds me of this age-old lesson: if you don’t understand it, don’t invest in it. If you do invest in something you don’t understand, then. it’s not investing — it’s punting! I don’t think this oil price plummet is a precursor to Armageddon but it does show how precarious the world economic situation will be until we start killing off this ‘business unusual’ phase of our lives.

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