Today was a historic day as West Texas Intermediate (WTI) crude oil futures price went into negative territory for the first time in history. Now I’ve seen a lot of people all over social media losing their collective “too-doo” and making end-of-days predictions but they need to calm the “firetruck” down.
The fact that the US benchmark for oil settled at -$37.63 per barrel which represented a 306% decline is indeed momentous but people are blowing the impact way out of proportion. The reason this may not be as big a deal as some people seem to think is because the cause of the crash is the result of the nuances of futures contract trading.
As we’ve explained on this page in the past (and you should review that post because it was a good one), when people say “oil prices” it refers to futures contracts that represent a claim on oil for delivery at some point in the future. You can take physical delivery of oil or you can close out your position using cash settlement. You can also roll your expiring contract over into a new contract. When traders hold a futures contract and want to roll it over to a new contract they first sell the old contract and then buy the new one.
Which brings us to what happened today. You may or may not know that the most recent WTI futures contract (May 20) expires tomorrow. Hence traders who don’t want physical delivery and want to roll their contract have to sell the May contract and buy the contract for June. Here’s the kicker, market sources are saying that there was one Exchange Traded Fund (ETF), which is basically a mutual fund that trades like a stock, that held 25% of the May 2020 futures contract. In order to buy the June 2020 contract the ETF had to sell the May contract at any price it could to get out. Thus precipitating the steep drop in prices seen today.
Now to get an idea of the true price of oil you just need to look at the price of the June 2020 contract with settled at $21.56 which is still down 64% year to date but nowhere near the decline seen today. It is important to also note that even though WTI is important, it isn’t the world benchmark for oil. That would be Brent North Sea Crude which settled today at $26.13.
So yes, oil markets have serious problems such as oversupply due to shale production, lack of storage capacity, almost non-existent demand due to pandemic related containment measures but the oil market is not dead so send them African pallbearers back inside.
Nevertheless, I still had to spare a thought today for the Minister of Finance because just seeing those headlines coulda give the “big” man a stroke. It probably was “taxing” on him.