TOP FARMER WEEKLY PERSPECTIVE 5/8/20 BY BRYAN DOHERTY
Will June Crude Oil Futures Trade to Negative Prices?
On April 20, the May crude oil contract experienced a magnificent fallout as prices moved to the lowest level in history, dropping from $17 per barrel to -$40 (yes, that’s negative $40). Futures recovered to $10 where the contract expired on April 21. What happened to create such a washout, and could the same happen to the June contract as it nears its last trading day?
The loss in futures price was caused by several factors, however, it was mainly a function of too many traders long a contract that has very specific and unique delivery requirements. In mid-March, the June crude oil futures contract was trading near $50, then experienced a drop of near $30, finding support at the $20 area. For nearly a month, the contract fluctuated between $30 and $20, in a range-bound pattern. This activity may have suggested that an equilibrium of supply and demand was trying to find a stable market price range. An agreement by OPEC and Russia to reduce supplies suggested prices may be cheap and, ultimately, owning crude oil seemed like a good investment. Hedge funds were aggressively buying value in the front month May contract. Yet, the effects of lost demand due to covid-19 suggested bulging supplies where measured through price on the futures market, which seemed to be indicating $20 was a support price. The exchange, however, did approve a measure allowing the contract to be able to move to a negative price, a move likely in response to huge open interest in the crude oil contracts. Traders who were long and wanted to exit needed to find a seller. This could be difficult if, at one point in time, many buyers were trying to exit. (A buyer needs to sell a contract to offset their position.) Open interest soared to well over 600,000 contracts by early April. The specifics of the contract require delivery at one facility in Cushing, Oklahoma. As the May contract neared its last trading day, futures began to come under pressure as, in fact, longs were trying to exit in order to avoid physical delivery. The stage was set, and prices collapsed. Buyers who intended to take delivery were likely patient until futures moved low enough. Once deep into negative territory, new buyers willing to take delivery emerged (offsetting the liquidating short positions). Those taking delivery were likely energy firms who had a need or wanted to secure the physical commodity.
A lack of demand and bulging near-term supplies suggest that the June crude oil contract, currently trading near $20, could potentially repeat the collapse that occurred with May futures. It is, however, unlikely. The collapse in prices was a wake-up call to traders (small speculators to large institutions) to pay attention to the calendar, and to have reduced or eliminate contracts well before last trading day. In response, many clearing firms are requiring traders (unless they intend to take delivery) to exit long contracts in June and July futures. Establishment of new longs is also prohibited. These steps and awareness that wild price fluctuations can occur with the energy futures contracts will likely prohibit the build-up of contracts in the front month as last trading day approaches.
If you have questions or comments, contact Top Farmer at 1-800-TOP-FARMER extension 129. Ask for Bryan Doherty.
Futures trading is not for everyone. The risk of loss in trading is substantial. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. Past performance is not necessarily indicative of future results.