I’m sure you are wondering what negative oil price means. And I’m here to explain to you what that is. A negative oil price means people with oil are paying you to take their oil at a loss to them. Just like when traders cut loss in a position. They are losing, so they are paying you to take the shares off their hands. They are forced sellers. How did they became forced sellers? I will explain.
Negative oil is something unique and we don’t have such facility in the Philippines. Negative oil happens in the futures market. Mainly in the US because they have a large futures market. The word “futures” means that a commodity is sold just before it is harvested. In this case, the producers of oil already sold the oil before it got sucked off the ground to a group of investors, traders or oil consumers (gas stations, airlines etc). This agreement to buy oil is called a futures contract.
The business of futures market
This is good for the oil producers since when they harvest the oil, they don’t have the risk of fluctuating oil price and lock in the profit even before they produce the oil. They can immediately sell the oil at an agreed upon price in the futures contract. And this is good for the traders, investors and oil consumers too, since they have a fixed price for oil, if the price goes up, by the time the oil gets delivered, they will profit from the market when they resell. So its a win win situation.
Now since this contract was made before the coronavirus problem, those people, investors, traders and oil consumers are now in a big problem. Why do you say that? Well, in the futures contract there would be a date in which these barrels of oil would be “physically delivered”. Meaning, if you bought the shares (a futures contract) of oil, those physical barrels of oil would be delivered to you and then you have to buy the said barrels of oil at agreed price in the futures contract. But they won’t be delivered to your house like a lazada or shoppee online shopping and delivery. Because that would be bad, having dozens and dozens of oil barrels in your backyard. What will happen is they will deliver it to a loading dock, a warehouse, in which, the problem arises.
Not only do you have to pay in full for all the barrels of oil in your futures contract, you also have to pay monthly for the storage cost of this oil until it gets sold. Which you probably have an inkling now how hard it will be since the warehouses are full and you have to store it yourself. On top of that, some traders are also leveraged, meaning, if the price of oil continues to go down, they are forced to sell at an even more loss..
So traders, investors and oil consumers that are stuck with oil have no choice but to pay other people to take the oil out of their hands. Since the cost of buying the physical barrels of oil plus the holding cost (warehouse) would be too much for them (a negative carry). If you’re stuck in the situation, not knowing when things will go to normal, while you pay the warehouse to hold your oil after buying each physical barrels of oil, then you might do the same thing.
Of course, if they are selling, then somebody else is buying right? Of course, this is a great time for oil investors to get great deals on oil. Its just like real estate in a sense you have to pay monthly for the interest payments and taxes while holding the real estate property until things settle down. I’m sure there would be lots of killing in the oil commodity and futures when things get back to normal but you have to have the cash to pay for the holding cost, which only a mindful investors with cash would have.
In every disaster there is opportunity. In every trader selling an asset at a loss, there is an investor who gains from that loss. Every cut loss is profit for an investor. Never be a forced seller. How do you avoid being the forced seller then? Well, you have to know value investing and start by using fundamental analysis in your due diligence. There is just no substitute for it.