Oil did something Monday that made even market veterans shake their heads in wonder — the thinly traded, soon-to-expire May contract for West Texas Intermediate crude on the New York Mercantile Exchange traded, and closed, in negative territory.
“I’m not sure how to react to that other than say that nobody, whether they’re 120 years old or whether they’re 20 months old, has ever seen an oil price lower than this,” Tom Kloza, a 40-year market veteran and head of global market analysis for Oil Price Information Service, told MarketWatch just minutes before the market closed.
Negative prices means someone with a long position in oil would have to pay someone to take that oil off of their hands. Why would they do that? The main reason is a fear that if forced to take delivery of crude on the expiration of the May oil contract, there would be nowhere to put it as a glut of crude fills up available storage.
Negative oil prices would also seem to be a foreboding sign about the outlook for an economy kicked in the teeth by the COVID-19 pandemic. At first glance, it would also point to ever-cheaper gasoline prices at the pump — a potential positive for hard-hit consumers.
The move was certainly emblematic of a historic bear market for oil, which has been sunk by the collapse of demand as a result of coronavirus outbreak and a brief but ugly price war between Saudi Arabia and Russia that added even more crude to an oversupplied market. But it also represents a phenomenon characteristic of futures markets, where wild price swings — albeit perhaps never on Monday’s scale — can occur around contract expirations.
Here are some key things for investors to consider:
The opposite of a ‘short squeeze’
The May WTI crude contract CL.1, 18.58% US:CLK20 closed Monday at -$37.63 a barrel, a one-day drop of $55.90, or 306%, according to Dow Jones Market Data. The May contract expires at Tuesday’s close. Any traders that are still long crude at that time must take physical delivery, while anyone short must make delivery.
What happened Monday in the futures market was effectively the opposite of so-called short squeeze, a phenomenon that may be more familiar to investors. In a short squeeze, traders that are short the market fear they will be unable to find the underlying physical commodity and are forced to cover their positions, driving prices up sharply.
On Monday, traders with long positions scrambled to get out amid a fear that it would be difficult to find a place to park physical oil amid a rising glut of crude. So in a way, Monday’s price action, while certainly bearish, was also something peculiar to the futures market, with the action in the thinly traded May contract not necessarily an accurate reflection of supply and demand fundamentals.
Source: William Watts | MarketWatch
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