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Negative oil prices have become a reality.
Yesterday, for the first time in the history of WTI-type oil, the quote turned negative, We could also see an oil price of less than $ 40, which at first glance was very difficult to believe. The negative oil prices of yesterday and today could have occurred in such a way that As a result of the dramatic decline in oil consumption, there have been almost no operators physically taking over the oil. and capacities are running out in Cushing storage at the WTI delivery point.
However, the tips only apply to the WTI product, which expires today and expires in May, for the time being, listing prices for later terms are still a big advantage per barrel. Liquidity is declining more and more relative to the May contract, and the contract was traded at the highest volume as early as June.
1. What does it mean to have a negative price of oil?
This specifically really means that the seller pays the buyer to remove the oil. All this extremely strange situation can happen in such a way that very few market participants dare to risk if there will be enough capacity available by the time the WTI futures contract is delivered. Because of this, there is complete panic among oil owners, so anyone who does not want to get involved in the physical problems of the oil market will have to sell the futures price delivered in May during operations today.
The transfer of the oil position is called this activity when the next oil futures contract expires and is rescheduled for next month’s expiration. This is not usually a problem under normal market conditions, but now if someone gets stuck by accident, they may have physical problems due to lack of storage capacity, which Reuters estimates could saturate in 2 weeks at the WTI delivery point in Oklahoma in Cushing.
2. What affects the price of oil?
The price of oil is affected by the same two factors as most of its assets, demand and supply. Demand is plummeting due to travel restrictions and coronavirus-imposed quarantines, with the International Energy Agency (IEA) estimating 29 million barrels / day of global oil consumption in May, a disappearance of nearly 30 percent of world oil demand. Such a decrease has never been seen before in the history of the oil market.
On the supply side, Russia and Saudi Arabia started an oil war in April after failing to reach an agreement on further production cuts in March. In practice, this means that the world market has been flooded with oil. The parties made peace again on Sunday, April 12, but the expected production reduction agreement of 9.7 million barrels / day will not take effect until May 1.
3. What is a futures contract?
A futures contract is a contract for the future sale of an asset at a price now negotiated. The transaction is futures because the transaction date and delivery date are different. So in practice, the WTI, which expires in May, can be delivered in May, but I can buy and sell it well in advance so that I can trade it without physically coming into contact with the product.
4. What is a contango?
Contango means that the price of long-term oil is higher than the price of the nearest maturity, which is the opposite of feedback. When the futures position is displaced, the expiration date is sold and the next one is purchased, they suffer a loss in each displacement due to contango. This effect is now very dramatic between the May delivery around zero and the June maturity trading above $ 15.
The contagion makes it extremely difficult for stock market investors to profit from rising oil prices, This is because large oil investment funds do not physically buy oil, but through futures contracts, so a significant part of future price increases may be lost.
5. What is paper oil?
Many investors only own oil on paper, so they want to speculate, cover, or arbitrate with black gold, but they don’t want to trade in their physical form. These players, and, for example, ETFs that invest in large oil tankers, are always used to changing their position on next month’s product, in a specific example, from the product delivered in May to June, when a contract expires, and So they can to achieve that, although they share the movement of oil prices, they never physically come into contact with it. Essentially, by trading the aforementioned oil futures, we can gain exposure to oil without closing the mysteries of the physical oil market by closing our positions in time for maturity.
6. Who is interested in a negative price of oil?
Negative oil prices are of no interest to Saudi Arabia or Russia, but the possible bankruptcy of the US oil shale oil sector. USA It is even more so. Americans are starting to profit from their production at $ 40- $ 50 in oil prices, so it may be in the interest of the two cartel powers to keep oil prices below this level permanently. Russia has previously stated that it can support such low oil prices for up to 10 years, and Saudi Arabia also has significant reserves of previously high oil prices. However, in the long run, the two cartel members may be successful, as a significant amount of supply may drop from the market and demand may rebound sharply after the coronavirus epidemic, accompanied by insufficient supply due to the closure of fields and lack of investment, leading to a drastic jump. in the price of crude oil. Therefore, Saudi Arabia and Russia could also interpret the temporary loss of income caused by current low oil prices as a kind of investment.
7. What is the difference between WTI and Brent?
WTI and Brent are different types of crude oil, that serve as a reference in the oil trade. WTI is oil extracted from the United States, that differs not only in origin but also in quality and delivery point Brent, which is mined in the North Sea. Brent is therefore a marine-type oil, making storage much less problematic than a land-based type of oil, WTI, so negative oil prices may have occurred in WTI.
8. How saturated are the containers?
In Cushing, Oklahoma, at the WTI physical delivery point, the amount of crude stored was 55 million barrels last Friday. The highest inventory level ever measured in April 2017, when there were 69 million barrels in stock. There could be 92 million barrels of total storage capacity in Cushing, with another 37 million barrels of storage capacity available. Assuming the current weekly stock growth rate of 5 million barrels, local oil storage could be full in two months. By contrast, oil traders have stated that there are in fact still unused capacities, but these are already leased, so virtually new buyers cannot rent space in the storage facility.
Globally, the oil market is in big trouble, with 1.3 billion barrels of free storage capacity available worldwide, and global oil reserves will increase by 100 million barrels every 4 days in April, so if Everything continues, they could saturate the world oil storage in two months. The Brent exchange rate may also be under very strong pressure.
9. Will the price of gasoline in the wells be negative?
Due to negative oil prices, the price of gasoline in the wells will not be immediately negative either., since, on the one hand, European gasoline and diesel prices are linked to the price of Brent crude oil, and on the other hand, the May deadline only causes negative oil prices for 1-2 days, in June the WTI quote can be very positive if local storage issues are resolved.
10. How can you earn money with all this?
It is physically impossible for a common person to enter the oil market as an investor, How could we solve the storage of hundreds or thousands of barrels in everyday life? So the paper is still oil, or investing through futures, but the biggest drawback here is that we fall too much off of that, and we may even be left out of much of the increase by having to pay huge premiums as we continue to scroll through each futures contract. You can also play with the current situation with options, however, in the same way, we could only place options in the futures product, where we would also face the disadvantage of a large contagion. However, it can be a good investment opportunity to buy shares of oil companies, which has the advantage that there is no contango, but we do not buy exactly the same exposure as for crude oil. The same is true for the shares of companies that provide oil services.
Cover image: Martin Divisek / Bloomberg via Getty Images
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