This Is Why the Oil Price Is About to ‘Surge’ $40 Overnight
If oil prices were genuinely as ugly as the nominal "crash" suggests, energy stocks would be getting obliterated too. | Source: Andrii Spy_k/Shutterstock.com
- Front-month U.S. oil prices plunged below zero for the first time in history.
- But they’re about to “surge” around $40 overnight.
- Both of those statements are at least partly true. And yet neither of them tells the whole story.
U.S. oil prices crashed to their lowest level ever on Monday, careening as low as negative $40 for a barrel of Texas crude. By Tuesday, the oil price is going to rally back past the $20 mark. But here’s the secret: Neither of those statements is entirely true.
Yes, front-month crude oil futures technically crashed below zero. And yes, front-month crude oil futures will trade above $20 on Tuesday. But in-between these two headlines lies a crucial event – and the key to understanding both today’s price “crash” and tomorrow’s parabolic “recovery.”
Why the Oil Price Crashed Below Zero
That event is the expiration of the May contract for West Texas Intermediate (WTI) crude futures, which occurs at the end of the trading Tuesday.
While futures expiration is typically uneventful, the rollover from May to June futures has been ravaged by extreme contango , a market structure that indicates near-term oversupply and longer-term bullishness.
You can read more about what triggered the historic price move here, but the short version is that whoever’s holding these contracts at expiration has to take physical delivery when the oil arrives in May.
That’s difficult because storage facilities in the landlocked U.S. oil sector are nearing capacity due to an unprecedented demand shock.
It’s a bottleneck problem. The market doesn’t expect the oil price to stay in negative territory forever. But neither do white-collar traders nor ETF administrators – like the U.S. Oil ETF, which reportedly controls more than a quarter of the open interest on front-month WTI crude contracts – want the headache of finding alternative storage.
As Bahnsen Group founder and chief investment officer David Bahnsen wrote over the weekend (when May futures were still trading near $20):
Market participants don’t really believe oil is going to stay at $20 for the rest of the year; in fact, they didn’t believe in $20 oil next week!! The roll of forward contracts are why the energy sector caught a bid late last week even as short term oil prices looked to be at record lows.
This explains why future-month WTI contracts, Brent crude, and major energy company stocks all traded with relative stability on Monday while the May contract crashed as much as 300%.
Why U.S. Crude Futures Will ‘Surge’ $40 by Tuesday
For example, WTI futures for June delivery fell 15% to around $21 on Monday. That’s not a banner day by any means, but it’s nearly $40 higher than the nominal U.S. crude oil price as of writing (negative $19.90).
Considering it will be the front-month contract as soon as May futures expire, it’s a far more accurate indication of what traders really think oil is worth.
If oil prices were genuinely as ugly as the nominal price suggests, energy stocks would be getting obliterated too. Instead, the Energy Select Sector SPDR Fund – a popular industry ETF – closed just 3.21% lower, only moderately underperforming the S&P 500 (-1.79%).
Of course, if OPEC+ production cuts and easing coronavirus lockdown restrictions fail to stabilize the oil market, it’s entirely possible the June futures will suffer a similar meltdown ahead of expiration next month.
