WTF, WTI?

Drive to your nearest petrol station, leave your credit card in your car and get paid to fill up. Essentially, that’s what happened this week in the oil market.

Makes perfect sense right? It’s unusual, but not insane.

This week, the May contracts for the world’s most liquid crude oil futures went negative.

On Monday, the day for the expiry of the May NYMEX WTI futures actually dropped below -$40, settling around $37. The contract expires in April, as delivery is required in May (i.e the May future).

Unlike stocks, futures contracts for commodities, actually require the seller to make physical delivery. This owner (buyer) of an expired futures contract, is obligated to take delivery of the commodity and are left to either use, on-sell or store the commodity.

With demand for Crude oil being so low and storage at capacity, there is limited demand for regular buyers of oil (airlines, refineries etc) to take any more.

The natural sellers of crude futures are the Producers – oil companies such as Exxon (XOM), Chevron (CVX), Helix Energy (HLX) and Northern Oil and Gas (NOG). These players also want to move their oil on – not wanting to eat the storage costs.

All this means is that those producers are aggressively looking for someone to take that oil off their hands. So much that they are essentially paying buyers to do so – i.e. “we’ll pay you to store this black gold.”

As unusual as it sounds, it’s really just classic supply and demand. Interest rates in Europe have been zero or negative for years now – it’s all about supply and demand.

Follow the action live

In futures contracts, it’s the quarterly contracts (June, Sep, Dec, March, etc.) where most of the volume is. So this month’s trading (The June contract) is going to be a better gauge for the market. If you want to follow it more closely, check out the CME pricing for NYMEX WTI futures here.

A little bit more about futures trading

The futures market are some of the most liquid instruments in the world. The market is not only for producers and buyers of commodities, but speculators too. Oil and energy companies make significant money on their speculation of the market – both managing the risk of their inventory but also trading the contracts for profit without the intention of accepting or delivering the physical commodity.

This means that only a percentage of the traded contracts actually remain outstanding. A measure of how much actual delivery is expected is measured by a contract’s “open interest” (aka open commitments). This number should be lowest right before expiry of a contract as all parties look to close positions they don’t want.

Come expiry, those trading from their garage or from 42nd Street in NYC are not expecting to take delivery or supply Lean Hog, Wheat or Corn when trading those futures. However, if they do let a position ride and forget to roll their contracts (i.e. where the speculator moves that exposure to a later months contract), they could be on the hook for some action in the physical market.

There are some very funny stories and myths in the market about investors having truckloads of soybeans delivered to their house, but it’s generally just that…a myth. Most futures brokers are on top of these situations and there is a process to offset or re-tender your position.