Why are we seeing negative crude oil prices?
By ATB Investment Management Inc. 21 April 2020 3 min read
On April 20th, 2020, the price of oil as defined by West Texas Intermediate (WTI) crude, went into negative territory. The CompassTM Portfolios have less exposure to energy relative to the broad Canadian indices, such as the S&P/TSX Index, and are typically less sensitive to the price movements in the energy sector. Let's review what happened yesterday and why we saw news around negative oil prices.
How could this happen?
The spot price of crude oil is determined by futures contracts—contracts that allow one to buy or sell a commodity, in this case crude oil, sometime in the future at a specified price and time. Futures contracts, such as those for financial instruments like equities or bonds, are paid in cash upon expiry. Commodity futures on the other hand, and in the case of WTI futures, often have physical delivery of the underlying commodity. Commodity spot prices are often tied to the nearest maturing futures contract. The futures market for the May contract stops trading on April 21st, and that is what actually turned the price of crude oil negative.
NYMEX WTI Crude Future May 2020 Contract price on April 20, 2020
Settlement of the WTI futures contract involves physical delivery of 1,000 barrels of oil to Cushing, Oklahoma. This is a location accessible to the international market via several pipelines, which is a positive.
However, the problem is that receiving delivery of crude oil requires storage, and with the slowing of the economy causing a negative demand shock, crude oil inventories have reached their maximum capacity. There is no room for crude oil storage, no matter what the price of that oil is. This caused forced panic-selling by the individuals that needed to sell their May contracts, facing the prospect of physical delivery, to the point where the holder of the contract was actually willing to pay to have others take delivery of the oil, hence the negative price. The negative price had to be justified in an effort to try and avoid delivery, freight, and storage costs, along with possible legal action from the exchange or clearinghouse.
What remains unknown over the coming weeks is what will happen with those individuals with open contracts, which are contracts that were not sold and will face settlement, once notice for delivery starts on April 23rd for deliveries scheduled to begin May 1st through to May 31st. It may still take a few weeks to see how the negative prices from May impact charges and delivery to those left holding the contracts.
What is the good news?
Those details and the April 20, 2020’s price anomaly aside, currently oil for June delivery is trading at positive prices. A producer can still lock in deliveries for crude over the next year at prices of $15-$30 if they choose to hedge the price of crude at this point in time.
What does this mean for investors?
This news can be problematic if you are in the business of buying and selling barrels of oil or if you are a petroleum exporting country. For the average investor, negative news creates uncertainty in the stock and bond markets which can cause short-term volatility (price movements).
The short-term volatility is not a reason to sell your investments or deviate from your long-term plan. As we mentioned earlier, the Compass Portfolios tend to have less exposure to the energy sector as compared to the broad Canadian market as measured by the S&P/TSX Composite index. While this can help protect our investors from volatility in the energy sector, it does not mean we are immune to it all together.
If you have questions about your portfolio please reach out to your advisor or contact us to speak to one of our wealth professionals.
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