US oil futures nosedive into negative territory; oil ETFs spared from carnage

Apr 21st, 2020 | By | Category: Commodities

Front-month US oil futures contracts crashed a staggering 307% yesterday with prices nosediving deep into negative territory for the first time in history.

US oil prices make incredible dive into negative territory

US oil prices crashed into negative territory yesterday, ending the day at -$37.63.

A barrel of West Texas Intermediate (WTI) crude oil for May delivery fell from its Friday close of $18.27 to a mind-boggling -$37.63 (as of Monday’s close), effectively meaning sellers were paying buyers to take their oil.

Prices have since rebounded a bit, although they are still pointing towards expiration in negative territory.

Oil price collapse

US oil prices had already plummeted in recent months, driven by a sharp reduction in energy demand resulting from the pandemic-induced economic shutdown at the same time that a feud between key producers Saudi Arabia and Russia was leading to an oversupply of crude oil.

This combination of record low demand and high supply has led to massive stockpiling of crude oil with analysts noting that capacity is likely to run out within the next few weeks.

With the futures contract for May delivery expiring today, speculative traders were desperate not to be stuck with oil they were unwilling or unable to take delivery of.

The pandemonium was primarily limited to US oil markets, however, with the price of the active Brent crude contract, for delivery of oil in June, trading 8.9% lower at $25.57. The dichotomy between the prices of the two crude varieties reflects the forced selling of the WTI contract immediately prior to expiration (versus June expiration for the active Brent contract) as well as the acute storage problems facing the US whose storage facilities are still catching up with the recent boom of its shale oil industry.

While US oil contracts for delivery later in the year were yesterday also firmly in the red, their decline was less overwhelming. The WTI June contract fell 18.7% to end the day at $20.40, while July delivery is currently priced around $26.

The resulting oil futures curve is thus displaying drastically steep contango (the price of futures contracts with later delivery is higher than those with nearer delivery), quantifying the present short-term discount on oil (a function of near-term oversupply), though also indicating in part that traders believe oil prices will bounce back as the world emerges from lockdown sometime in the summer.

The ongoing supply of crude oil is also expected to taper off somewhat in May as a pact between major oil producers, led by Saudi Arabia, Russia, and the US, to cut output by 9.7 million barrels per day comes into effect. After yesterday’s turmoil, these countries are reportedly negotiating an immediate curtailment of production.

Nitesh Shah, Director, Research, at WisdomTree, said, “While there’s little reliable data on storage global capacity, pricing signals indicate that storage is getting very tight. With WTI trading negative in the front month, people were being paid to take oil and store it.

“It may turn out that the most sensible place to store the oil is where it came from i.e. for drilling activity to slow down considerably. Last week we had the largest weekly decline in US oil rigs in operation since 2015. Production decline is likely to accelerate in this price environment. Through market forces the US may indeed end up cutting production as much as Saudi Arabia and Russia are through coordinated cuts.”

However, with oil producers unlikely to completely shut off the spigot for fear of losing market share (or even being unable to restart their pumps), and if the economic shutdown drags on, future expiring oil contracts (e.g. June and July) may go down a similar route as the May contract.

While many futures traders will undoubtedly have suffered crushing losses, major ETPs tracking WTI crude oil contracts were largely spared (thus far) from the worst of the carnage yesterday as many of these products had already rolled their contracts into June or beyond.

For example, the $4.1bn United States Oil Fund (USO US), the largest ETF worldwide to provide exposure to oil prices, rolls its contract two weeks prior to expiration. The fund did, however, fall significantly yesterday in line with the price of June’s oil contract.

Similarly, the LSE, Borsa Italiana, Euronext Paris and Xetra-listed WisdomTree WTI Crude Oil ETC (CRUD LN), Europe’s largest oil ETF with $858m in assets (as of close yesterday), had already rolled over into the July contract. It tracks the Bloomberg Commodity Oil Subindex which was fully exposed to the May contract until 7th April but started rolling over to the July contract between 8th April and 15th April.

Some of the investors in these products – many of whom are potential “oil tourists” – will likely be running for the exit now, while those more bullish investors choosing to dig in their heels should take heed: the steepness of the futures curve implies that investors stand to lose significantly if these subsequent contracts roll down to similar levels that May contracts were trading at even last week.

Committed oil investors might wish to investigate products investing in longer-dated futures, such as the WisdomTree WTI Crude Oil 2mth ETC (OILW LN), where the curve is flatter, or ‘enhanced’ products, such as the WisdomTree Energy Enhanced ETC (BENE LN), which provide exposure to indices that purport to deploy optimized roll mechanisms which minimize the potential losses arising from contracts in contango. (BENE tracks the BNP Paribas Optimised Roll Energy Total Return Index, offering broader energy sector exposure.)

However, with the timing of the pandemic’s end still uncertain, and oil inventories continuing to pile up, oil seems like a very risky bet indeed. More than ever, investors need to carry out comprehensive appraisals before executing any investments in the sector.

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