In Surreal Oil Market, Nomura’s McElligott Asks: ‘What Is The Utility Of The Futures Contract Itself?’

It’s easy to get mired in the somewhat tedious details of the “technical oddity” that was Monday’s epic wipeout in crude.

But throughout, I’ve been consistently insistent (hooray for pseudo-alliteration) on alluding to the bigger, macro picture.

For example, on Monday evening, I wrote that the debacle in crude “runs counter to central banks’ efforts to reflate the global economy and speaks to why there is still extreme trepidation in some corners about the prospects of an upturn in inflation expectations engendered by various forms of stimulus, both monetary and fiscal”.

Crude’s historic adventure in negative Neverland is, in many respects, a deflationary supernova begat of another deflationary supernova – the coronavirus epidemic.

There is nothing “reflationary” about the stunning visual below.

Calling Monday a “technical oddity” is something of a misnomer. The plunge in the June contract on Tuesday shows the fundamental backdrop which had traders so terrified of physical delivery is in no way altered by a contract roll.

Nomura’s Charlie McElligott underscores this in a note out Tuesday.

“Yes, the stunning move yesterday in front-month WTI was ‘technical’ in that it reflected the total and complete lack of storage capacity into physical settlement [but] there is obviously a very real disinflationary impulse off the back of oil’s chronic oversupply dynamic in conjunction with the COVID global demand shock”, he writes.

That’s why you saw Brent nosedive and why the loonie, NOK and the ruble were all under pressure.

“In the US we can see a national utilization rate of 64.5% and Cushing utilization rate of 70%”, Deutsche Bank’s Michael Hsueh wrote, in a Monday note. He continued:

These numbers do not sound alarming, until you calculate that at the pace of last week’s record storage builds, they imply national storage reaching capacity in 14 weeks, but Cushing storage reaching capacity in only four weeks. If this were taken down to the next-smaller level of detail, of individual operators, then we would almost certainly see that some operators already have reached capacity.

This brings me to a crucial point – and I mentioned this earlier in an exchange with a friend. There’s something existential about this. 

It barely makes sense to analyze the situation when there’s no storage. What happened Monday (and the ripple effect it will have over the next couple of weeks) is another example of financialization bumping up against reality – of abstraction colliding with the tangible.

McElligott echoes that assessment in his Tuesday note.

“The entire strip for both WTI and Brent are collapsing in unison, because yes, there is nowhere to put the stuff but also because market participants believe things won’t be getting much better into the future either”, he writes.

“Nobody needs it”, Charlie goes on to say, before asking the following:

And without storage – since you cannot take physical delivery – then what is the utility of the futures contract itself?

That line resonates not merely as an assessment of current market dynamics, but as a broader comment on the extent to which, at times like these, we’re forced to confront a harsh reality – namely that the instruments we dabble in as market participants cease to have any real meaning beyond certain thresholds.

I would argue that we hit that threshold on Monday. I used the following chart in a previous piece, and I’d like readers to consider it in the context of everything said above:

As you can see from the legend, that is a continuation series of monthly spot prices for WTI dating back nearly to World War II, as maintained by the St. Louis Fed.

The red dot is Monday’s settlement for the May WTI contract.

If you’d be inclined to suggest that chart is meaningless, I would be inclined to respond as follows: “Exactly”.