Negative oil price – how, why, and what it means for investors

Oil prices made history yesterday. For the first time ever, American oil traded at a negative price, reaching lows of less than -$40 a barrel.

Investors will be quick to remember 9 March, just 6 weeks ago, when global oil prices plummeted more than 25%. The knock on meant the FTSE 100 opened 8.7% lower.

Expect yesterday’s record to cause some jitters – volatility will likely spike. We’re in unchartered waters, but it might not be as bad as it seems on the surface. This crash is a bit different.

WTI versus Brent oil

The difference this time is that the price crash is affecting a certain type of oil. West Texas Intermediate (WTI).

WTI is extracted from oil fields in the United States, whereas Brent comes from oil fields in the North Sea. Both are considered high quality and are relatively easy to refine.

Most of the time there’s a high correlation between the two – the prices largely move in sync. But whereas WTI suffered greater than 100% losses, Brent ended the day less than 7% down.

Why is WTI worse off?

The coronavirus outbreak has left lots of us in lockdown. We’re not driving, factories are temporarily closed, and we’re simply not consuming as much. Lower demand for energy means a lower demand for oil.

But isn’t this a global thing? It is, but the situation in the US is unique.

It’s been caused by the futures markets. Futures contracts are a way of buying something (in this case oil) at a set price at a predetermined time in the future. You can lock in a price now for delivery later down the line.

The key difference between the two types of oil is that most US oil is stored at a place called Cushing, Oklahoma. Oklahoma is a landlocked state, so it gets very expensive to transport excess oil. Brent on the other hand is extracted from the sea and largely kept on coasts or ships – it’s easier to move around.

Normally traders sell their futures before the end of the contract to avoid oil turning up at their office. But yesterday they found they couldn’t sell their futures as no one was willing to buy.

WTI contract holders found themselves stuck needing to accept the barrels without anywhere to store it. That’s what’s split WTI from Brent, and led to the sellers paying buyers to take it off their hands.

Land of the free (oil)

The futures contracts causing negative prices are those for delivery in May. The same problems haven’t yet extended to June or July. Though they did fall 18% and 11% to just over $20 and $26 respectively.

What does that mean going forwards?

Earlier this month President Trump promised oil-industry leaders the government would revive the sector. We’re not sure how long negative prices will last, but it’s difficult to see a scenario where producers are happy to keep drilling in these conditions. Jobs are probably at risk.

Should I consider buying some?

We don’t think so. Investors using a platform like HL can’t effectively access the futures markets. The most efficient way to speculate on oil price is by using an exchange traded commodity (ETC).

Oil ETCs usually own a mix of different futures contracts that end on different dates. As contracts for June onwards are still trading in positive territory, the price of ETCs hasn’t gone negative. ETCs can be a lot more complicated than first meets the eye – you might not be getting what you think.

There’s also something called contango to think about. Contango is normal in futures markets, and means that a price in the future is higher than today’s price. An ETC manager has to roll over all these contracts at higher prices, eating in to any returns – it’s one of the reasons exchange traded products don’t always follow the price of what it’s tracking closely.

Surely it can’t go lower? Likely the exact thoughts of buyers last Friday. You can wait for it to climb? Contango can be a huge uphill battle – it’s worse when volatility is high.

Then what should investors think about?

First, equity (shares) and bond markets aren’t nearly as driven by futures as commodities like oil. Most investors own their investments outright, and shares and bonds don’t have the same storage issues. While the oil story is a first, we don’t think this will extend to other asset classes.

Oil price shocks did hurt the FTSE 100 last month though.

We’ll probably see ripples through the stock markets over the coming days or weeks. However, our view goes unchanged. Don’t try to time the market.

Volatility works both ways – we’ve seen some of the big daily stock market daily gains follow the big daily losses. Remember past performance isn’t a guide to the future. If you sell, you’ll probably consider reinvesting at some point. But staying invested can be less risky than trying to time a sale and repurchase, in our view.

Stick to your long-term plan and keep a good mix of investments. It’ll maximise your chances of investing success.

For more insight and tips to help you keep on track, you can sign up to our weekly email sent straight to your inbox every Saturday morning.

This article is not personal advice. It is not a recommendation to buy or sell any investments. All investments can fall as well as rise in value so you could make a loss. If you’re unsure if an investment is right for you seek advice.

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