We hope this finds you well. Here is a recap of this week’s performance in the S&P 500:
This week, the price of West Texas Intermediate (WTI) Crude Oil went negative. In effect, commodity traders paid other people to take it, much like you would with trash. This was the first time this ever happened in history – so how is it possible?
Demand for crude oil has decreased significantly as a result of the recent pandemic (this also translates into lower gas prices). This means less oil needs to be refined, so the excess crude goes into temporary storage. These storage facilities have been reaching capacity and there is increasingly little space to store oil. With storage options dwindling, no one wants to own oil and the responsibility for figuring out where to put it. As a result, there were no buyers, and the price crashed into negative territory. In other words, oil became like a hot potato.
As the week has gone on, the WTI oil market has stabilized as buyers have returned to the market. For traders or producers who can store oil, there is potential for profit by purchasing it now at low prices, storing it, and moving it in a few months for higher prices. As a result, prices have bounced back as more traders seek to capture this spread.
The following chart shows the price of oil for delivery throughout the remainder of 2020:
Source – 4/23/2020 Chicago Mercantile Exchange – https://www.cmegroup.com/trading/energy/crude-oil/light-sweet-crude.html
The chart shows prices tend to be higher further in the future because of the cost associated with storing oil. The May futures contract expired shortly after trading negative, but the June contract is well back into positive territory.
So, what does this mean for you?
There are funds that invest in crude oil futures contracts. One example is the United States Oil Fund (USO). Recently, investors have been flooding this fund with new money in hopes of profiting from an increase in oil prices. The main problem with USO is that the fund can’t take delivery of oil – they instead roll futures contracts as they expire each month. This means that in many cases, the fund doesn’t track the current oil price well and is in a position to be a forced seller, which is not ideal. So we don’t consider this to be a viable option for clients.
While this was a historic event in oil, its effects on the broader market have been somewhat minimal. We have continued to see higher than normal volatility in stocks, but much lower volatility than we saw in March. In general, energy stocks have also not been negatively affected – the market is expecting this to be a short term event that is unlikely to affect the longer term price of WTI crude.
All this oil talk reminded us of a classic theme song – let us know if you remember this!
Please reach out to us if you would like to discuss this further.
