‘We’re Going To Hear About Crazy Losses’: Epic Oil Wipeout Poised To Ripple

The wipeout in crude is not contained.

Monday’s epic collapse that found the May contract erasing all value to settle deeply negative spread to June futures on Tuesday, a sign that the “technical oddity” aspect of this week’s historic plunge is but one facet of a many-sided problem.

June WTI futures fell as much as 42% to $11.79/barrel before trimming some losses. Brent, meanwhile, fell sharply and at one point traded down near $18.

The May WTI contract – the locus of Monday’s wild collapse – traded well below zero again, although the market is obviously very thin.

Subzero prices are now a fixture, apparently. All manner of grades are in negative territory.

Again, the issue on Monday in the May WTI contracts was ultimately about the impossibility of the paper market converging with the underlying commodity when there’s nowhere to store physical barrels.

“Negative oil prices mean that producers are effectively willing to pay someone to move their crude”, Goldman wrote, in a postmortem. “While this is already happening in Texas and Canada, [Monday’s] WTI move reflects the fact that holders of May contracts were effectively willing to pay someone to get them out of their long positions before expiration to avoid being physically delivered crude oil next month, when storage capacity will have run out”.

The bank spells it out even more explicitly as follows:

The May CME WTI contract expires [on] April 21. Any holder of a long position going into settlement would then be obligated to take delivery of crude in Cushing during the month of May (either by transfer into a designated pipeline or storage facility or by in-tank transfer). This means that an investor long a WTI May contract would be forced to sell out of this position (at any price) before settlement to avoid being stuck having to find room for barrels in the Cushing storage hub which will likely be completely full by then (it is 77% full as of last Friday with the last 2-week builds pointing to stock-out by the first week of May).

Rotterdam-based Royal Vopak NV, the largest independent oil storage company on Earth, told Bloomberg that “the available capacity on the oil side is almost completely sold out for our terminals”.

That linked piece (by Fred Pals and Jack Wittels) contains all manner of amusing anecdotes including the proposition of “traders send[ing] tankers on odysseys to find the best places to stash supplies”. (I love the word choice – “odysseys”.)

Just to give you an idea of how ubiquitous oil’s epic collapse really his, here is SocGen’s Kit Juckes with a bit of charming color (from a Tuesday note), and some perspective:

My youngest child came in to supper last night asking about oil prices. How come they are negative, and is it true that the dollar’s value is linked to oil? We discussed contango, storage and the difference between Brent and WTI, but he still can’t get his head round the fact that his mother was once an oil trader. Back then, when Brent fell from $30p/b to under $10p/b, the S&P didn’t blink and just marched on higher, while the dollar just went on drifting lower in its post-1985 correction. The idea that a lower oil price is some kind of global economic calamity (as opposed to a shock for some countries and some industries) is a bit odd.

You’re reminded that retail investors poured $1.6 billion into USO last week in an attempt to call the bottom. As I put it on Monday morning, it is readily apparent that not everyone putting money into these products understands how they work (i.e., either hasn’t read the prospectus or doesn’t understand the language in it). There is a structural issue here – this isn’t like buying SPY after a 30% drop.

Last week, USO said it would shift some of its holdings to the second-traded month due to the exigent circumstances or, as the fund puts it in the filing, “because of market conditions and regulatory requirements”.

Pierre Andurand has serious concerns about the whole sitaution. “[I’m] wondering what would happen to USO and other oil ETFs that mainly hold June WTI if June WTI goes negative before the roll”, he said Tuesday.

“I think the CME might have no other choice but to close out the ETFs positions”, he went on to muse, adding that the exchange “cannot take the risk to have negative prices before the roll and be on the hook. We are going to hear about crazy losses in the days and weeks to come”.

Weighing in, Goldman wrote that while the June contract outperformed significantly on Monday, it’s likely to come under pressure over the next few weeks due to “the potential exit of spooked long retail investors given the violence of [Monday’s] move and the negative carry incurred at each contract roll” as well as “the negative impact of investors rolling their long positions from the June to the July contract in early May (the USO rolls on May 5-8)”.

Through it all, the underlying issue persists. As Goldman puts it, “ultimately, the market surplus that will hit binding storage capacity in coming weeks [is] still unresolved”.