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Intro
A sudden drop in Crude Oil prices Monday [4.20.2020] led to a dramatic selling frenzy that pushed the commodity's price to $0 per barrel. Oil futures contracts for the month of May closed at -$37.60. A negative price means that Oil producers will literally pay you to take and store oil for the month of May. June 2020 contracts are currently trading at $20.93 so traders expect some sort of normalcy in the future, however, this price may drive lower as expiration approaches.
Traders noticed halts in trading on their brokers, no liquidity, and/or mis-pricing. This led to some traders being closed out of shorts that they would have won, or longs that they would have closed. Trading is a relative game so there needs to be someone on the other side of the trades in order for brokers to be able to execute orders. Brokers were halting shorts on some brokerages because there would be no buyers on the other side of the orders in order to liquidate the position. Long story short a lot of brokers went/will go bust, and others just had liquidity issues with their LP (Liquidity providers).
This is a combination of an oversupply x Non-existent demand x Storage issues x Political Pressure.
The recent Oil war has caused a recent surge in Oil production. This Oil needs to be stored and kept somewhere until it is purchased. Due to recent quarantine conditions there hasn't been much demand for Oil. Cruise-lines are docked, airlines are grounded, and cars are collecting dust at home, meaning the demand for oil is also at all time lows. What we saw in the oil prices today are simply a result of oversupply and no demand. Now it gets more complicated when you factor in the fact that oil is a physical commodity that needs storage. Storage capacity is limited so the producers will become desperate and will need places to store, driving the price even lower to make it more attractive.
Potential Next Steps:
1) The major oil companies will reach out to the White House and request help in dealing with the issue. The Executive could either purchase some oil from the strategic Petroleum Reserves (SPR), allocate bail-outs for the companies, or some combination of the 2. This may lead to a consolidation of many oil companies and could result in the federal government buying pieces of this new conglomerate.
2) All U.S oil companies reduce production collectively and stabilize the supply and demand curve. This may be too late to reduce the damage on oil prices but it will help prevent a storage crisis. We have some breathing room in our regional storage capacity but that may not last another month of over-production.
3) The supply numbers release lower than expected and the market demand kicks in to buy oil and drive price higher. Based on the early numbers that are coming in it doesn't look likely that the actual figures will be low. The imbalance between supply and demand will grow wider if the figures are higher than expected.
Global Political Conflict
- Oil shocks tend to hurt developing nations the most. Countries that are resource-heavy depend on oil exportation to drive revenue. With demand at 0 there was already a strain on these countries to generate income; that may be getting much worse. If these countries have to start giving away their primary resource for dirt cheap/free then it could have sustain damages on the productivity of that country.
- Tensions between Oil producing nations will lead to conflict on the global stage, unwillingness to cooperate, and an increase in hostility. At the main stage of this conflict is U.S. and China. These two nations are still involved in a trade war despite phase 1 being signed and the current circumstances of the virus. This current oil shock could lead to a Dollar demand scenario, resulting in the U.S. levying higher tariffs on exports.
- Russia, who started the oil conflict, will side with either China or the United States. It is unlikely that they'll support the U.S. so this will lead to a greater divide and potentially more conflicts regarding oil productions and price control.
Buying Oil in a Falling Market
Traders have been talking about buying the bottom all morning., The saying "never try and catch a falling knife" comes to mind. Don't try and guess a bottom because in this territory, there isn't one. If you're trading oil then watch the technicals/fundamentals. Here are some key things to look for:
1) Futures contracts for the month of June, July, and August are trading at $20+. This shows that traders expect some stability in prices in the coming few months.
2) Options contracts start seeing an inflow of call options being bought for Oil. This shows that the options speculators are expecting a rebound in price as well.
3) Look for Oil inventory data to release so we can see how much extra oil we're dealing with and what our storage capacity is. If we have too much oil, not enough room to store it, then price will drop even further.
4) Look for some agreement from the White House to support the oil companies in stabilizing price or in staying in business.
5) Keep an eye out for news about potential flare ups in the newly agreed on terms for the Oil war. If any country violates the agreement then the price war will get worse and will cause ripple effects throughout the entire economy.
Disclaimer: This article is the result of the analysis carried out by analysts associated with ChartAddicts. The article does not purport to represent the views or the official policy of ChartAddicts. This is not investment advice.
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