Why the oil price fell below zero and what are other examples of negative prices. What lessons can we learn from negative prices.
Topics covered include:
- How oil futures work and why the oil future prices fell below zero for the first time ever.
- Why has the United States Oil ETF (USO) lost so much money.
- How ETF authorized participants create new shares only so they can be shorted.
- How storage problems for oil and electricity can lead to negative prices.
- How negative interest rates are another form of negative prices.
- Why sellers will pay buyers to deliver a service to them.
- What financial lessons can we learn from negative prices.
Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today is episode 296. It’s titled, “Why Do Negative Prices Exist”
Negative oil prices
Last week the price of the May 2020 West Texas Intermediate Crude Oil Futures Contract, known as WTI, fell to as low as -$37 per contract. That means the holder who was loaned oil was willing to pay to exit the contract.
CNBC Markets reporter Pippa Stevens wrote, “On Monday for the first time on record, West Texas Intermediate, the U.S. oil benchmark, plunged below 0 and into negative territory. Before Monday, many thought this was impossible. Maybe, just maybe, it could drop to 0, effectively erasing all value. But negative territory seemed unimaginable, not least because it’s hard, even to wrap one’s mind around it. Pay someone to take your oil?”
In this episode, we’re going to see why oil prices went negative. We’ll also look at other examples of negative prices and why they exist and what we can learn from them.
A closer look at oil
The WTI Futures Contract has a physical settlement, which means whoever holds the contract when it expires, receives a barrel of oil. The contract settles in Cushing, Oklahoma. That’s where that barrel of oil is delivered. If you own the contract that’s where you’re going to get your oil, or at least arrange for somebody to store it for you.
U.S. crude inventories are near an all-time record high. And in Cushing, Oklahoma 70% of the storage capacity was full as of mid-April. And a Reuters article suggested that most of the available spaces are already leased out. There’s nowhere to put that oil that is being received as part of this futures contract settlement.
Now the May oil futures contract has since expired and now the June oil futures contract is the front-month contract that will expire in the 3rd week of May. Yesterday the June contract fell 25% to just under $13. The United States Oil ETF, USO, fell 15%. It has lost 83%, year-to-date. Leveraged exchange-traded funds tied to oil have shut down. They lost all the money. Products by WisdomTree, UBS, and VelocityShares, which is owned by Janus.
United States Oil Energy ETF
Jim Cramer said, “There are times in life where people know that there’s an instrument that is faulty and they can shoot against that instrument and bury these people.” There is this financial problem, people who are buying the USO, the United States Oil Energy ETF. They are financial people, so if you’re a real person or if you’re a large contractor, a large player, they can wipe out the USO.
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