Free Oil: A World in Recession. The Unthinkable Happened

WTI, for the first time in history, has been traded in negative territory when the futures with delivery in May dropped as low as -40$, to close the settlement at -37.63$ per barrel (a record of -300% in daily trading). This is an event that seemed to be impossible only a few weeks ago, as it means literally that if  we flew to Texas yesterday,  to buy 1 barrel of oil, we would have been paid by the seller.

How did we get to this point?

The June contract has been trading low on Monday, but still in the range of 22$ per barrel. This difference in price between the two futures is given by the contango in the oil market: futures with later expiries have usually higher prices because they discount the price for storage.

The main US oil trading hub in Oklahoma has declared no space left in their storage. On one side, this is happening due to the Coronavirus, because of the global lockdown, the oil demand has dropped drastically. The effect has also been amplified in March by the “oil production dispute” started between Russia and Saudi Arabia, which has created an oversupply and lack of storage, affecting oil prices

Just on April 12 Donald Trump spoke about a deal between US, Saudi Arabia and Russia, which had led the WTI prices to spike up to 29$ per barrel, but what was not taken in consideration was the dramatic systemic failure, where oil demand would have dropped so quickly, because of the coronavirus and isolation.

May contract with expiry on 21st April, given the looming expiration, has been characterized during the session by low volumes, providing favorable conditions for the price to drop further.

The low prices of the recent days had attracted huge buy interest, even from retail, for these contracts that involve the delivery of barrels at maturity. However, almost none of the speculators who were long on WTI, plans to have 1,000 barrels delivered to Oklahoma, so they resell the contract before the expiration.

Rush in closing those positions in an illiquid market has been exacerbated by panic. It was initially said that the movement could be caused by the roll of futures of USO (United States Oil Fund), the largest oil ETF, but the reality is that USO was completely out of the first contract. As a matter of fact, USO on Monday had lost 12%, less than the second contract (June, which lost 15%)

How to deal with this situation?

In recent weeks, the CME (Chicago Mercantile Exchange) had prepared contingency plans to deal with the possibility of the price of a barrel going below zero. To solve these potential difficulties, NYMEX seems to have taken in consideration the Bachelier model, which unlike the most popular systems, based on the Black-Scholes theory, allows to price options even when the underlying asset has a negative value. This means we are reshaping the modern economic theory.

WTI has since gone back above zero, then dropped bellow again and at the time of writing is trading at around 11 USD.

If you can find where to buy WTI with normal spreads and swaps. We here at Mayfair Brooks, recommend that you do so at the physiological level of 0 USD. Without jokes though and not being able to get in properly into Oil futures without the broker taking all your money on with the swap. It’s a good idea to invest in stocks which are Oil and Energy centric.

We have created our own basket of stocks which we have invested in: Occidental Petroleum, ConocoPhillips, Baker Hughes, ExxonMobil, Royal Dutch Shell and Phillips 66 with the majority of the money being put into the latter two.

Remember though. It won’t get better overnight and it’s a long play where you buy and hold the stocks. It might even get worse before it gets better.

The article was written by Rosario Pisana, Chief Trader and Analysist at MayfairBrooks