This is the story behind the historic oil crash

Forex chart

21.04.2020 – Special Report. History is being made in these days: Yesterday the barrel of West Texas Intermediate for delivery in May temporarily traded at minus 40.32 dollars, before the contract hanged back to just over 0 after several panicky hours. Besides the oversupply, there is an explanation from the financial market for the phenomenon. We explain the background.

Negative price for oil contract for the first time

Even hardened traders rubbed their eyes yesterday: For the first time since the launch of futures trading in 1983, the price of the expiring futures contract for US crude oil of the reference grade West Texas Intermediate for delivery in May has fallen below zero. The May contract was settled yesterday for a negative $37.63. On Friday the closing price was still at plus 18.27 dollars.

Massive tearing of stop-losses

In fact, yesterday’s situation in reverse is comparable to the historical short squeeze on Volkswagen shares – because the liquidity for the oil contract dried up completely yesterday. Nobody bought when everyone was selling at the same time. Yesterday around noon US time, countless stop losses were activated when the contract touched the 10 dollar mark. So you see: never set stops at round marks, but always just before them.

Clueless speculators

Roger Diwan, Vice President for Energy at IHSMarkit, explained the situation. IHSMarkit is a listed information service based in London. The crash is related to the expiration of the May contract today. Whoever holds the contract at maturity will also have to purchase the oil in May at the pipeline node in Cushing, Oklahoma. However, since speculators have no storage capacity and since it is hardly possible to buy it there at the moment anyway, financial players would have had to get rid of the futures under all circumstances. It is possible that some players did not understand the aspect of physical purchase.
Diwan added that yesterday’s situation did not necessarily indicate the future market situation, as the June futures contract on NYMEX closed yesterday at plus $21.13. However, the June contract was by no means safe – the Cushing market was not in good shape and inventories were gradually running out.

Mom-and-Pop-Crash

Goldman Sachs took the same line and told its customers exactly who had sold in a panic yesterday. Because of the difficulties and costs of storing oil – even in normal times – experienced investors never held a contract until it expired. As a result, long positions had shrunk as large ETFs (Exchange Traded Funds) had already rolled in their money. In recent weeks, however, more retail traders have entered the market, Goldman continued. This is shown by the increase in retail exposure, for example in the USO ETF.
We add: By Friday, April 17th, there were still over 100,000 open positions in the May contract, which is well above the five-year average of 60,000. This indicates that yesterday an above-average number of amateurs were still holding the expiring contracts. Our conclusion: Mom-and-pop day traders threw themselves the hot potato, i.e. a contract in which they did not understand that in the worst case, tons of oil would be delivered here.

New fireworks threaten May and June contract

Goldman Sachs also warned of new disasters. Commodity strategist Damien Courvalin first pointed to “potential further distress ahead of the settlement window” at the end of the May contract today.
And this should not be the end of the pain for the bulls; now the focus is shifting to the June contract, which expires on May 19. According to Goldman, there are three reasons for its collapse: First, the massive move yesterday may have driven some long retail investors out of the market. Second, there is likely to be a negative effect when many investors roll their positions from the June to the July contract in early May. Third, the question of oversupply and storage capacity remains unresolved.

The lagers overflow

In recent weeks, US oil inventories have risen by almost 20 percent, the highest level in about three years. And this in the middle of a severe recession. At the same time, tankers are increasingly being used as floating storage facilities. Experts estimate that the volume in tankers doubled within two weeks to a record 160 million barrels.

At last it had looked like a relaxation: As announced by US President Donald Trump, Russia and Saudi Arabia had agreed on cuts in production. De facto, Moscow has caved in. This came as a surprise to many market participants. Trump also briefly provided support yesterday evening when he reiterated his intention to buy 75 million barrels of crude oil for the Strategic Oil Reserve.
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To get oil in USA for 40 dollars cash

Nevertheless: The US market is drowning in oil. Producers are currently paying premiums to have their barrels taken away. At the bottom of the page is a list of offers from the trading house Plains Marketing: all prices for regional oil types are negative. If you currently have a demand, for example, you will receive 54 dollars cash on hand when you buy a barrel of South Texas Sour or around 39 dollars when you buy a barrel of Oklahoma Condensate Light.

It gets exciting once again

Our conclusion: Today at 14.30 US East Coast time, the May contract may become explosive again, as normally only about 2,000 contracts are delivered. We wonder if all investors have gotten rid of their unwanted May contract for physical delivery. Also for the June contract and for the following months, the only certainty is that nothing is certain. A veritable oil tsunami is rolling towards the market. As a result, other, later oil futures could also soon suffer from consumption.
The Bernstein Bank stays on the ball for you!


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