There is no question that we are in unprecedented times. Therefore, what happened last week in the oil market shouldn’t come as a major surprise. Last week the price of a barrel of crude oil on the futures market fell to nearly minus $40/barrel. Yes, you read that right, they were willing to pay you $40/barrel to take the oil. The price for the same barrel of crude was selling for $15/barrel at the beginning of the week. In simple term what that means is that for every barrel of oil that an investor owned, not only would they lose their initial investment to buy the barrel of oil, but they would also lose another $40/ barrel. I know this sounds crazy, but that’s actually what happened. However, I think it is important to understand why it happened.
It is important to first understand what is happening in the oil markets. Basically, the world is swimming in oil. Storage facilities for oil throughout the world are filling up. In fact, there are numerous tankers that are full of oil at sea with nowhere to go. At the same time, demand has dropped dramatically. Because a good portion of the world’s economy is shut down, the demand for oil has dried up. Therefore, it’s simple economics -– when supply goes up and demand goes down, prices fall.
There is another important factor to understand, and that is how oil is traded. Oil is traded by future contracts. Traders buy and sell future contracts, and when those contracts expire, whoever is holding the contract must take possession of the oil. What that means is that if you are the holder of a future contract on the day the contract expires, you have to take physical possession of the oil whether you want it or not. The May oil future contracts all expired last Tuesday. Therefore, because the demand for oil was so low and storage facilities are at capacity, traders who did not want to take possession of the oil and who were holding expiring contracts, literally were forced to pay people take possession of the oil. This is the first time this has ever happened. Personally, I think this was an aberration as it had more to do with future contracts and how oil is traded, as opposed to anything else.
The initial inclination of many is to say lower oil prices mean lower costs at the pump, and that’s good for consumers. However, one thing you have to consider is that there are literally millions of Americans employed in the oil industry. If U.S. oil producers have to shut down their wells, not only will we see another spike in unemployment, but our economy will also take a hit. We should not forget that the U.S. is now one of the leading exporters of energy in the world. It’s not like it was 50 years ago when the U.S. was so dependent upon foreign oil. Today, it’s a different world.
In my view, there have been no winners in the recent decline of oil prices. (Despite the fact, that a gallon of gas is about $1.00 less than it was a year ago.) Keep in mind, even though we have cheaper gas prices at the pump, most consumers can’t take advantage of it. After all, most of us are driving a fraction of what we did a couple months ago, and therefore, we really are not getting the benefit of lower prices. In my opinion, everyone loses and there are no winners.
Rick is a fee-only financial advisor. If you would like Rick to respond to your questions, please email Rick at firstname.lastname@example.org.