Oil Prices Made History

Oil prices made history yesterday. For the first time ever, American Oil traded at a negative price, reaching lows of less than $40 a barrel.

Investors will be quick to remember 9 March, just 6 weeks ago, when global oil prices plummeted more than 25%. The knock-on meant the FTSE 100 opened 8.7% lower.

Expect yesterday’s record to cause some jitters – volatility will likely spike. We’re in unchartered waters, but it might not be as bad as it seems on the surface.

WTI Versus Brent Oil

The difference this time is that the price crash is affecting a certain type of oil. West Texas Intermediate (WTI).

WTI is extracted from oil fields in the United States, whereas Brent comes from oil fields in the North Sea. Both are considered high quality and are relatively easy to refine.

Most of the time there is a high correlation between the two – the prices largely move in sync. But whereas WTI suffered greater than 100% losses, Brent ended the day less than 7% down.

Why Is WTI Worse Off?

The coronavirus outbreak has left lots of us in lockdown. We are not driving, factories are temporarily closed, and we are simply not consuming as much. Lower demand for energy means lower demand for oil.

But isn’t this a global thing? It is, but the situation in the US is unique.

It has been caused by the futures markets. Futures contracts are a way of buying something (in this case oil) at a set price at a predetermined time in the future. You can lock in a price now for delivery later down the line.

The key difference between the two types of oil is that most US oil is stored at a place called Cushing, Oklahoma. Oklahoma is a landlocked state, so it gets awfully expensive to transport excess oil. Brent, on the other hand, is extracted from the sea and largely kept on coasts or ships – it is easier to move around.

Normally traders sell their futures before the end of the contract to avoid oil turning up at their office. But yesterday they found they could not sell their futures as no one was willing to buy.

WTI contract holders found themselves stuck needing to accept the barrels without anywhere to store it. That is what’s split WTI from Brent and led to the sellers paying buyers to take it off their hands.

Land of the Free (Oil)

The futures contracts causing negative prices are those for delivery in May. The same problems haven’t yet extended to June or July. Though they did fall 18% and 11% to just over $20 and $26 respectively.

What does that mean going forward?

Earlier this month President Trump promised oil-industry leaders the government would revive the sector. We are not sure how long negative prices will last, but it’s difficult to see a scenario where producers are happy to keep drilling in these conditions. Jobs are probably at risk.

Should I consider buying some?

We don’t think so.

Oil ETCs usually own a mix of different futures contracts that end on different dates. As contracts for June onwards are still trading in positive territory, the price of ETCs has not gone negative. ETCs can be a lot more complicated than first meets the eye – you might not be getting what you think.

There is also something called Contango to think about. Contango is normal in futures markets and means that a price in the future is higher than today’s price. An ETC manager has to roll over all these contracts at higher prices, eating into any returns – it is one of the reasons exchange-traded products do not always follow the price of what it’s tracking closely.

Surely it cannot go lower? Likely the exact thoughts of buyers last Friday. You can wait for it to climb? Contango can be a huge uphill battle – it is worse when volatility is high.

Then what should investors think about?

First, we do not promote equity (shares) and bond markets we prefer futures in the form of CFDs for commodities like oil. We trade in CFDs and hold open our trades for such a short time-span that we do not suffer large losses on any trade.

We will probably see ripples through the stock markets over the coming days or weeks. However, our view goes unchanged. Do not try to time the market.

Volatility works both ways – we have seen some of the big daily stock market daily gains follow the big daily losses. Remember past performance is not a guide to the future. If you sell, you will probably consider reinvesting at some point. But staying invested can be less risky than trying to time a sale and repurchase.

We stick to our trading plan and keep on scalping for profit. It maximises your chances of investing in Oil successfully.

Neil G Van Luven

Neil G Van Luven signature

President of the Crude Oil Investment Club