Yesterday I thought we were in for a historic day when the price of oil (as measured by the May WTI futures contact) opened below $13. Then it fell below $10… and $5…. and $1… and then zero. By the time the contract settled, a barrel of oil cost an incredible negative $37.63.
It was only for a brief time yesterday that we experienced negative oil prices, but the entire futures curve has taken a hit. As of writing, a barrel of oil (June contract) has already fallen over 40% this morning to under $12 at one point.
Capitalizing on that decline, President Trump is using the opportunity to build America’s Strategic Petroleum Reserve. According to Fox Business:
President Trump plans to turn the financial bloodletting into an opportunity for the United States.
“Based on the record low price of oil, it is at a level that is very interesting to a lot of people, we’re filling up our national petroleum reserves, strategic reserves and we are looking to put as much as 75 million barrels into the reserves themselves that would top it out, that would be the first time in a long time its been topped out and we’d get it at the right price,” said Trump.
The SPR was created between 1973-1974 after the oil embargo, as noted by the U.S. Department of Energy. Its purpose is to act as a shield against the disruption or depletion of oil supplies for the U.S.
If Trump’s plan gets approved by Congress the SPR would act as the motherload of U.S. storage purchased on the cheap.
“We’ll ask for permission to buy it or store it one way or the other it will be full” he added.
That news aside, I’m sure many are wondering how it’s even possible that the price of oil went negative yesterday.
How the price of anything can go negative seems impossible, but what we witnessed yesterday represented an immediate shortage of storage, exacerbated by an exchange traded fund (ETF) that owned a large share of the May oil futures.
According to Forbes, the ETF “USO” (which tracks oil prices) poured gasoline on the fire (pun intended). The fund owns 25% of all the May WTI futures contracts, and cannot take delivery of oil, meaning that they have to sell the expiring contracts at any price before they expire – in yesterday’s case even if it means paying someone to take those contracts off of them. Even if they could take delivery, there’s such a shortage of space right now that it’s entirely possible that for at least a moment yesterday, the cost of storage exceeded the price of oil itself.
In other words, what happened amounted to the opposite of a short squeeze:
With that contract set to expire Tuesday, the buyers of that “paper oil” have to sell or take physical delivery at the end of May. ETFs like USO are not created to take physical delivery of the oil contracts they hold, so in a long squeeze, the fund’s managers—USO’s general partner/sponsor is U.S. Commodity Funds, LLC (USCF) and, according to an 8-K filed on March 30th, the administration of USO will transition from Brown Brothers Harriman to Bank of New York Mellon, although it is unclear whether that change has been fully implemented—have to dump oil.
