Explaining the Negative (Below $0) Oil Price That Occurred Today

Cory Mitchell, CMT

It was strange, the May contract was under selling pressure all day, and when it got under $5 the conversations really started exploding in trading circles and on social media. When it ticked below $0, well, things got unprecedented. It was a bit like a car crash no one could stop watching. 

While it made for an interesting day and crazy headlines, it is a one-day event, for now. 

Negative oil prices happened for a number of reasons.

  • The May crude oil contract is expiring. A futures contract is an obligation. Holding a futures contract till expiry means buying and taking delivery of the oil for a buyer, or selling and delivering the oil for a seller.
  • Buyers were obviously in trouble. They were dumping their contracts today, at literally any price! Even negative prices! Why?
    • The main reason is there is no place to store it. You can buy it, but you need somewhere to store and maintain it. Such places are already at full capacity.
    • This created a perfect storm for anyone who bought and was still holding contracts. Taking delivery wasn't an option.
  • Add to this that demand for crude oil is low due to the coronavirus quarantines which are hampering business around the globe. Then we also had a lot of supply due to the OPEC and Russian feud last month, where they proclaimed they would keep pumping oil. 

Many conversations went the direction of "I'll store it my back yard and sell it later!" It is not that simple. Exchanges require strict oversight of the product in order to maintain the trust and integrity of the market. 

If you are interested, the CME rulebook, chapter 200, outlines the standards for the oil, delivery, and storage. Fail to maintain those standards and the oil is not (re-)sellable on an exchange.

The May contract has so far traded as low as -$40.32. It opened at $17.73. 

A One-Day Event

The negative oil prices only affected the May contract, showing that this is a storage shortage and expiring contract issue. 

While the June contract was down nearly 16% on the day, the price of oil for that month is still in positive territory above $21.

That is not to say something like this couldn't happen in the future. Come June, the same thing could happen again if the storage and demand issue isn't any better. The oil-producing nations have agreed to cut production to help stem the oversupply.

So far oil traders are expecting the situation to be better. The August contract is trading at $29, September at $30, October at $31 and December near $33 (all rounded).

CADJPY

The CADJPY, a currency significantly affected by moves in oil, was down marginally, -0.67%. In light of recent volatility, currency traders viewed the excitement in oil as little more than a blip. As mentioned, so far, negative oil prices are an isolated one-day event where some oil-futures-buyers got royally roasted, yet oil contracts expiring at later dates are still trading above $20 (above $0).

Canada is a major oil exporter, and Japan an oil importer. This makes the pair correlated to oil. But it is not correlated to just one oil contract, it is correlated to overall view in oil. If oil keeps falling on the near-term contracts, that will likely weigh on the pair going forward.  That said, the CADJPY also has other forces acting on it, not only crude.

While the pair didn't sell off aggressively today, the recent rounded top formation indicates the price could slide lower if it breaks below recent swing lows near 76.

Other Implications

Many futures trading risk models and algorithms are likely based on a $0 price being the maximum loss on a futures long trade. Those assumptions have now proven to be false. We'll see in the coming days if any funds made such assumptions and now face liquidation/insolvency.

Disclaimer: Nothing in this article is personal investment advice, or advice to buy or sell anything. Trading is risky and can result in substantial losses, even more than deposited if using leverage.

Comments

Forex Trade Ideas

FEATURED
COMMUNITY