!-- End Google Tag Manager (noscript) -->

Analysis of the fall in the price of oil

2 min. reading
Financial Education, Investment, Market news / 23 April, 2020

Héctor Ferreiro Portfolio Manager

The price of West Texas Intermediate crude, closed last 19th April 2020 at – $ 37.63, something that seemed impossible. It has never closed negative at maturity before. The Price on the spot contract was also negative, due to the lack of storage.

 

Crude Oil is a commodity, not a financial asset, and therefore it trades with certain peculiarities, among them:

  • It is bought or sold through futures with different maturities, and at the maturity of the contract they are either exchanged for the next maturity or it is collected physically at its delivery point
  • Depending on the maturity of the future, it can be quoted at very different prices, as we are seeing these days
  • The asset does not reward its holder with any income.

Crude Oil does not receive stimuli from the Central Banks, as it happens with other assets, so we can consider it the most reliable signal of real economic activity.

Taken all of this, the price of the markets is very difficult to replicate with financial vehicles.

The current situation is due mainly because of the drop in the demand due to the Coronavirus crisis, and excess supply that occurred in previous months (Russian/Saudi Arabian Oil war). The US tried to stabilize prices by buying crude oil but caused inventories to rise and warehouses to collapse in Cushing, Oklahoma, where WTI barrels of oil are delivered at the maturity of the contracts, as said.

On the other side, although it has been also affected, the Brent price has remained more stable, mainly due to its easier delivery characteristics and fewer inventory levels.

If an individual investor thinks about buying oil now with negative prices, he could encounter certain problems:

  • Storage
  • US government fees to trade with hydrocarbons

If we choose another maturity (June contract for instance), despite the price now is not negative, if the situation of the COVID-19 prevails, it could happen again.

Barrel prices above these levels put different market members in trouble:

  • Countries whose economies depend on oil
  • Companies in the sector, more vulnerable to fracking and upstream.