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Oil Contracts Collapse Putting Pressure On Stocks

Published

6 years ago

April 23, 2020

The price of West Texas Intermediate (WTI) crude oil product hit a historic level on Monday as it posted its worse loss on record. According to MarketWatch, “the May contracts made history by settling in negative territory for the first time ever.”

The platform was so broken that sellers were paying buyers to take the contracts off of their hands. So, Monday, April 20, 2020, will go down in history as the day that the price of oil broke down.

The futures industry is a very risky but popular business. The fact that its movements can impact the direction of the stock market, makes it a key indicator of economic activity at home and abroad. In a recent report, Pvmreports.com suggested that the activity in the oil futures proved that the market was broken.

I read in an essay where it said, “Even though perceptions and expectations are powerful ingredients in the formation of oil prices, (Monday’s) price crash must have taken place in some kind of parallel universe.”

For those who are not familiar with how oil futures work, “The Motley Fool,” an on-line stock advisory group, defines the product as, “contracts in which buyers and sellers of oil coordinate and agree to deliver specific amounts of physical crude oil on a given date in the future. “

The benchmark futures contract for crude oil in the U.S. involves West Texas Intermediate, which produces a particular grade of oil that has fairly low density and sulfur content that makes it relatively easy to refine. It has historically traded on the New York Mercantile Exchange, and therefore many traders refer to the contracts as NYMEX WTI crude oil futures.

Trading is also common globally for what are called Brent crude oil futures, which involve a different grade of oil found in the North Sea off the European continent.

While some speculate that Russia and Saudi Arabia conspired to artificially bring down oil prices in order to disrupt the U.S. stronghold on oil exports, it is clear that the pandemic has had an effect: When people stay home, oil use simply goes down.

So, for Wall Street traders, “Bizarro World” was in full effect on Monday. Even if that date isn’t marked in the future as a day of financial infamy, it will certainly be the topic of discussion in a lot of business schools.

One of my colleagues, Harbo Jensen, who is an MIT graduate and retired oil company executive, described the event in simple terms to help lay-people like myself understand what happened.

“You are now seeing the financial paper traders struggling to get out of contract under which they would need to take actual delivery of oil in May at Cushing, Okla.,” Jensen said.

“Clearly, these guys want to find a buyer for their paper contract because they really don’t want that real ‘wet’ barrel of oil….these paper barrel traders would not know what to do with a barrel of real oil if they had to pick it up, so they’re willing to pay someone, say $15-$20 to take it off their hands. Hence, the negative price.

“If there is anyone who thinks that this pandemic in which we live is not real, they should just look at the standstill that we are seeing in the oil markets. It seems surreal that global economies have been shut down by this virus, and if you do not believe it, let’s see how low the price reveals itself at the pump. We may be able to keep our tanks full, but we will be all dressed up with nowhere to go.”