Market Update April 20th, 2020

The shocking headlines just keep coming. Today it was the oil price shock. Predictions of possible negative oil prices came true today as May oil futures contracts closed at -$37.63 per barrel. Not only was it the largest single day price drop in history (-306%), it was also the first time WTI futures fell below $0. But don’t let the headlines worry you too much. This was a temporary anomaly affecting only the May contracts that expire tomorrow.

Most investors trading in oil futures (which set oil prices) never intend to take physical possession of the oil, and it was obvious that some very big player or players got themselves trapped in these May contracts with nobody to sell them to and nowhere to store the oil if they took delivery. Bloomberg sources last week suggested that United States Oil Fund, one of the largest and most liquid oil ETFs (ticker USO), held 25% of the outstanding May 2020 WTI oil futures contracts, so they are the most likely suspected instigator of today’s historic decline. It appears that once oil storage space filled up and the managers of this ETF realized they couldn’t store the oil even if they wanted to take physical delivery (which they didn’t), they had to dump all of their futures contracts at whatever price they could get today, before they expire tomorrow. That of course turned out to be a hefty negative price, meaning they had to pay dearly to get someone to take these contracts. There are usually always at least refineries or airlines to sell the contracts to, but today’s stay-at-home orders mean they didn’t want this May contract oil either.

Unfortunately, today’s negative oil price doesn’t mean free gasoline and free oil changes for us. It also doesn’t mean curtains for the oil industry. The June oil futures contracts (that expire in May) are still trading above $20 per barrel, which is a better representation of the true oil market today. If the oil market were dead in the water, the June contracts would be negative as well. Instead the ridiculously wide spread between the May and June contracts confirms that the market experienced a one-off event.

While today’s oil price developments aren’t as bleak as they appear, there is still plenty of trouble ahead for the oil industry for a while yet. Storage is filled up, demand has dried up until stay-at-home orders are lifted, and supply has yet to be adequately restricted. But longer dated futures contracts suggest that most oil traders expect oil prices to be back up around $30 per barrel by the end of the year.

The bottom line is, when you close down large swaths of the private sector economy like this, crazy things happen in the markets. This is just the latest example, and it won’t be the last. The important thing in my opinion is keeping our heads and not reading too much into any economic, earnings or market statistic today, and resisting the temptation to compare them to prior history, or using them to extrapolate future predictions. We need to view it for what it is…a temporary situation while the economy is in this self-induced coma.  Today it was the oil shock. Tomorrow it will be another surprising/not-so-surprising temporary statistic. A more detailed update will be coming shortly. I just wanted to address this shocking oil price news today and put it in proper perspective.