Headlines had oil selling at -$37.63 per barrel at close on Monday, April 20. The negative sign in front? Sellers had to pay buyers $37.63 to take the oil off their hands. Except this wasn’t the price of oil. It was the price of a useful financial instrument, called a futures contract, in this case a contract for delivery of oil in May at a particular price. The nearest futures contract in date is often used as a proxy for the price of oil, since it trades regularly and usually tracks the price of oil well. But on Monday, quirks in the futures market created an artificial price that, while historic and capturing the extreme stress we’re seeing in the oil market, was not quite the same as the actual price of oil.
“Many people were shocked to see that oil prices turned negative,” said LPL Research Senior Market Strategist Ryan Detrick. “Futures contracts were about to expire, oil is tough to sell, and expensive to store right now.” Speculators tried to close positions as industry buyers blindsided by the collapse in demand stepped away, creating a situation where the loss was preferable to taking delivery of the oil.
The combination of an expiring contract, plummeting oil demand, little available storage, and very light volume all conspired to create the historic day. But that was for futures contracts for delivery in May. As shown in the LPL Chart of the Day, later delivery dates were still above $20 / barrel on Monday. But even these prices represent tough times for oil producers and oil producing regions. Yesterday’s price anomaly is another example of how efforts to contain the COVID-19 pandemic, even if necessary, are creating unprecedented shocks in the economy and financial markets. Combine that with high levels of production, and current struggles in the oil market are little surprise.
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The term Futures refers to future contracts, a financial contract obligating the buyer to purchase an asset (or the seller to sell an asset) at a predetermined future date and price. Contracts detail the quality and quantity of the underlying asset, and are standardized to facilitate trading on a futures exchange. Futures are used to either hedge or speculate on the price movement of an underlying asset, such as a physical commodity or financial instrument.
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