Historic Oil Crash
Today, it is all about oil. When a low probability, high severity risk events happen, things blow up. That’s why we call it a ‘Black swan’ event.
The largest Oil ETFs like USO who owns 30 % of the outstanding volume in oil contracts are not created to take physical delivery of the oil contracts they hold. However, a perfect storm was already building up for the way it happened yesterday.
More than half of the global economy is in a shutdown (demand destroyed) and two of the most powerful oil producers collude to flood the world with oil that the world cannot handle. World storage capacity was already up to brim. Nobody wants physical oil delivery. not now. If it was gold, one can at least store it. I have a spare water tank but don’t think I am prepared to take physical oil in that.
The futures price for May needs to be offset by tomorrow (Apr 21). The June contract has also fallen but by a much lower margin.
There is no economic situation that could possibly justify single-digit prices for oil. So, this is a technical situation and the market is in huge contango now. Bank of New York, the administrator of USO, is forced to dump oil.
Companies that store oil on a temporary basis are the big winners on this.
There are three things that could stand in oil’s favour going forward. With the shale production becoming prohibitively expensive marginal US production can fall to zero. Production curtailments by OPEC and Russia will work its way through the market but it will take time. Oil should be again in demand when the COVID-19 situation will start to ease.
The Fed thought that they can create inflation at will, but oil showed that the market has a mind of its own.
So, history was made yesterday in the oil markets. The May contract plunged to -$ 40.30 intraday. We had alluded to prices dropping back again when oil ran up a few weeks back but never expected something like this.
Be safe. Be small. Be home.
Abraham George is a seasoned investment manager with more than 40 years of experience in trading & investment and portfolio management spanning diverse environments like banks (HSBC, ADCB), sovereign wealth fund (ADIA), a royal family office and a hedge fund.