April 21, 2020

Negative Oil. Which Oil?

Alaric Securities

By Nikolay Stoykov, Managing Director, Alaric Securities

In case you missed it, WTI May futures traded negative 40 USD/barrel yesterday. Having some experience in the space, I received a lot of questions – what does this mean, where are we going from here, etc.

WTI – A Broken Promise

WTI May 2020 Futures on Intraday Graph 

Let’s address them one at a time…

First, when people talk about oil, they usually refer to WTI. However, WTI is really just one of more than 100 widely quoted types of oil. Even more than that WTI, as a volume of world production, represents no more than 1% of total. Yes, it is popular and certainly heavily traded but less than 1% of trading volumes actually go into delivery. More than 99% of the trading volumes come from hedgers and speculators that never take delivery.  Unless you live in the state of Oklahoma, WTI price really has no impact on what your gas station charges.

Second, WTI contracts have only one delivery point – Cushing, Oklahoma. I suggest you go on Google Earth and see where that place is. But the last time I checked, that was deep in the continental USA, far away from any port and possibility of a tanker loading the oil. That is a very, very big problem because the storage facilities in Cushing have limited capacity and as of today – NO CAPACITY. It is the responsibility of the buyer of WTI to find that storage…

Moreover, the storage charge which in good times is usually about 1-2% a month has become exorbitantly high and now running at approximately 20 USD/barrel per month. And to cap it all, this charge varies per day…Who is to say where the limit on that charge is. Can it go to 50 USD/barrel per month? I am not sure, but I was startled to see that CME last night listed options on Jun 2020 WTI contract with -50 (negative 50) strike.

I can go on and on but I think it is unnecessary. WTI spot and future prices have become totally disconnected from other world oil blends. We do NOT expect that disconnect to disappear anytime soon and we expect it to wreak tremendous damage on investors in the energy sector.

Here is how investors can protect themselves:

  1. Avoid WTI based ETFs like USO and USL. Most likely those ETFs will be liquidated, however, the big question is can USO go to 0 during the next roll period – May 5 to May 8.
  2. If looking for oil beta exposure look at Brent Futures and ETFs like BNO which are based on them.
  3. Best of all, for long oil exposure look at oil stocks or ETFs like XLE. There is a reason why Warren Buffett does NOT trade futures – 6 sigma events tend to happen a lot more often in the futures markets than most statistical models indicate.

This is not a recommendation. The information provided is an objective and independent explanation of the matter. Alaric Securities OOD and other entities of the group do not trade in the above financial instruments.