Acumen’s Commentary on Drop in Oil

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04/21/20

Out of everything we have seen in the financial markets thus far in 2020, the jaw-dropping collapse in the price of Crude Oil contracts set to expire on Tuesday might be the most jarring. The price of West Texas Crude fell into negative territory – minus $37.63 a barrel – meaning sellers were paying buyers to take the contracts off their hands. The reason for the collapse is most likely due to the complete absence of room to store the physical barrels by which the contracts trade on. Nobody wants to take delivery of the actual contract because there is nowhere to store the physical oil. Typically, the holders of oil futures contracts will either sell the contract and roll over the position to the next month’s expiration, giving someone else the physical delivery of the asset. Today, the price of contracts for May 20th delivery completely collapsed as there was absolutely zero demand to cover the contracts rolled off to the next month. This can be displayed by the difference in the May 20th expiration contracts and the June 20th expiration contracts. This was more than likely an anomaly, as the event was something traders likely had never input into their risk models, and we will likely never see something of this effect again. There are implications though. We now have a better grasp on just how little demand there is for the delivery of physical oil – as the global economy has pretty much come to a standstill while there has been a lack of decrease in output. As for investors wishing to make substantial allocations to the distressed asset, we don’t fully know the medium-term effects of what is happening in the oil market since this is unlike anything we have ever experienced. While the price of next month’s contract is not likely to plummet as we have seen this time, without substantial pickup in demand for the commodity, its volatility could be tumultuous. We don’t believe in attempting to catch a falling knife. Until we have a better understanding of the fundamental implications of the physical oil market disruption, we remain pessimistic on the commodity. Until then, the most attractive investment in the space seem to be energy companies with high-quality balance sheets, such as the ones currently held in Acumen-managed client portfolios. These investments will likely gain from the eventual recovery in the oil market with now more limited downside.

Chart provided by Bloomberg L.P. as of April 20, 2020.

 

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Grant Allen, Portfolio Analyst

About the Author: Grant Allen is a Portfolio Analyst for Acumen Wealth Advisors in Chattanooga, TN.  Grant holds a Bachelor of Science in Finance-Investments from the University of Tennessee at Chattanooga’s Gary Rollin’s College of Business and has successfully passed Level One for the Chartered Financial Analyst® (CFA®) designation.  The CFA® consists of three levels of exams, each requiring a recommended 300+ hours of study, minimum of four years of work experience, and multiple letters of recommendation.  Exams cover Quantitative Methods, Economics, Financial Reporting and Analysis, Portfolio Management, Wealth Planning, and Ethics.

 

 

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