WASHINGTON – Contango. No, actually, it’s not a new dance. But it is a term investors and consumers will need to get acquainted with this spring. It involves the price of crude oil, specifically West Texas Intermediate (WTI), the yardstick measure for US oil prices. The price of WTI plunged Monday morning. Big time. As CNBC crisply informed us before Monday’s opening bell on Wall Street. Even worse: the rest of the market plans to follow oil on the way down.
“U.S. oil prices tumbled to their lowest level in more than 21 years on Monday, with crude storage facilities filling rapidly as the coronavirus pandemic continues to crush demand.
“The May contract of U.S. West Texas Intermediate (WTI) futures fell to $12.43 a barrel on Monday, down more than 31%. That’s its lowest level since March 4, 1999…
“Meanwhile, international benchmark Brent crude stood at $26.63 on Monday, around 5% lower for the session.”
Why the spectacular waterfall decline in crude oil prices?
With the greater part of the developed world still on a massive coronavirus lockdown, with few people driving, with international air transport in a virtual halt and with business at a standstill, almost no one, statistically speaking, is fueling up.
And with oil producers still pumping away, even at a reduced rate, they know there’s no place in the world to store it anymore. Bizarrely, oil tanker companies that were staring bankruptcy in the face only a few weeks ago – since no one wanted the oil they were supposed to carry – are experiencing a life-saving jolt in business.
But with international storage facilities filled to the brim, the only remaining place to store all this excess oil is on those heretofore-unemployed tankers. And you have to pay them to store it. So they sit in ports around the world, filled to capacity and making money by going nowhere. What a world we live in.
Do these clouds have a silver lining?
For the oil optimists in the crowd, there’s a bit of a silver lining in today’s oil price disaster, notes CNBC.
“To be sure, the sell-off of the May contract comes ahead of its expiry on Tuesday. The June contract of WTI, which is more actively traded, stood at $22.85 a barrel, almost 9% lower.
“The current forward crude oil curves for Brent and WTI are now in very deep contango, but the contango is also very front-loaded,” Bjarne Schieldrop, chief commodities analyst at SEB, told CNBC via email.”
Doing the contango
Contango. There’s that word again. The term “contango” describes an essentially upside-down oil market. In a normal oil market, the selling price of crude oil is normally higher for oil available right now as opposed to oil that refiners and consumers might need a few months in the future. I.e.,if you need the oil right now, you’ll have to pay more for it than if you’re contracting to buy oil for delivery several months in the future.
But when oil prices are “in contango,” the situation flips. That means that buyers of oil are suddenly less willing to buy the stuff near term, for a variety of reasons. But at some conjectural future date, they might be a lot more eager to buy it. So the contracts for oil delivered in the future go up in price, while contracts to buy oil right now become much cheaper.
CNBC illuminates us further on the cause and effect of contango.
“A contango market implies oil traders believe crude prices will rally in the future, encouraging them to store oil now and to sell at a later date…
“The current forward crude oil curves for Brent and WTI are now in very deep contango, but the contango is also very front-loaded,” Bjarne Schieldrop, chief commodities analyst at SEB, told CNBC via email…
“‘The curves are saying we have a big problem with the storage of oil right now, Schieldrop said, noting the general market view seemed to be that the global economic trough and the oil demand trough would be April 2020.
“In the second half the year, he continued, the problem of storage capacity should ‘vanish rapidly’ because oil demand is expected to rebound strongly, while inventories will draw down sharply.”
Well, that’s a relief. But this doesn’t help investors in crude oil futures or oil stocks – including refiners – one bit Monday morning. If investors plan to hold these equities, they might wish to hedge their positions by writing covered calls. The alternative? Wait for a hoped-for bounceback in these stocks Tuesday morning when current April oil contract expires and the new May contracts take the pricing helm. Or just get out on the bounceback while the getting’s good.
Applicable cliché: It’s always darkest before the dawn
With many US states and a number of foreign countries beginning to loosen coronavirus quarantine restrictions on individuals and businesses over the next few weeks, cars, trucks and planes will once again head for the fuel pumps, although slowly at the start. This will be at least a mild tonic for oil prices.
But it is likely to take consumption (demand) a considerable amount of time to get back to some semblance of normalcy. Meanwhile, the world will not need any new oil. We need to begin working down the vast surplus that already exists. So it will take oil companies a much longer time to recover equilibrium if not profitability. And as a result, a number of smaller players, particularly in the US, will almost certainly go under.
All this weighs heavily on Monday stock market action, as most individuals and businesses have at least some interrelationship with the price of crude and thus the price at the pump. So, even after Friday’s enjoyable bull market stampede, it looks like the bears will take over Wall Street Monday in a nasty start to the trading week.
Stay tuned for an update article later in the day. Maybe even two.
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