Well, there’s another first.

We all woke up on Monday to a crashing oil price that eventually went negative on the May futures contract for the US oil benchmark (West Texas Intermediate oil for delivery at Cushing, Oklahoma).  The concept of a “negative” oil price had been discussed in analyst research for some time as the effects of demand (a decline of 25-30% globally) combined with the effects of supply (Saudi Arabia deciding to flood the market anyway) creates a problem with storage (where do you put the oil coming out of the ground until demand rebounds?).  Conceptually at that point, the producer would have to pay someone to take the oil away from the wellhead.

Something else was afoot here though.  The negatively-priced futures contract on Monday heading into expiration the next day (Tuesday) had a significant number of contracts still open.  Financial speculators had to close out their position to avoid physical delivery of the oil (which is how the futures contract is settled).  The same close-out happened to hedge funds who were playing the big difference in price between the May contract and the June contract.  They were surprised to learn that a futures contract price could fall negative and saw their trade move against them.  Oops.  A great analysis by energy investment banking firm Tudor, Pickering, and Holt reviewed the futures trading data to show that, despite the headline negative prices, only a modest fraction of the day’s volume actually traded at negative prices.

We will likely see a second occurrence as we approach the June contract if speculators do not learn how to roll their positions farther in advance.  Futures are tricky in the best of times and even more so right now when prices move steeply up the further you go on the calendar (what traders refer to as “contango”).  An exchange traded fund (ticker USO) that uses the futures market to provide smaller traders access is having its own tough time…and it is hurting those folks who think they are taking advantage of an opportunity but unfortunately are not even aware of the complexity .  Like anything in investing, you have to do your homework.

In addition to “firsts” we are also seeing “fourths”… as in the fourth stimulus package to roll out from Congress.  This iteration refills the capacity of the Payroll Protection Program (PPP) and sends more money to health care efforts.  The tab continues to grow.  A new package is announced and the talk of another begins.  As each State Governor looks to announce their “re-entry” plans this week, the government is looking to put some momentum behind business activity as it starts back up.  Infrastructure packages.  State and municipality support.  Extensions of unemployment benefits.  Lots of topics are on the table, especially in an election year.  But as the tab grows, so does the probability for tax increases in the future to offset current spending being funded by debt or monetization.  We are borrowing from the future, so we better make these investments work.

But that sentiment is not a first.

Will Skeean, CFA

Partner – Investment Management Team Chair