As I understand it, today's oil price meltdown was triggered by an oil ETF called USO.
Unlike gold ETFs that hold physical gold, oil ETFs like USO hold no physical oil. The way USO works is that it holds contracts for delivery of physical oil next month (in this case, contracts for delivery on May 20). Then, on the 20th of the month, it sells those contracts and uses the proceeds to buy contracts for delivery the following month (in this case, contracts for delivery on June 20). Ordinarily this works just fine, because the volume in USO is typically pretty low and there are usually plenty of real oil buyers out there willing to pick up USO's contracts on the 20th and take delivery of the physical oil.
Lately, however, speculators have been putting billions of dollars into USO. So today, as it rolled over to next month's contracts, USO dumped all those billions of dollars of May 20 delivery contracts onto a market with very few real oil buyers willing to take May 20 delivery of physical oil.
USO's Brent oil counterpart BNO works the same way and has been getting similar inflows from speculators. My understanding is that Brent oil delivery contracts roll over on the 29th of the month, so a similar meltdown may be coming in Brent oil on April 29.
Also, after today's meltdown we may see some of the demand from speculators go away, and the price of oil stay down at a level that reflects the actual demand from people and companies with licenses to take physical delivery. Added to all of this are the problems that the world's oil storage space is filling up fast, and the reopening of the economy in June is likely to encounter lots of logistical bottlenecks that may slow down the return of oil demand. So I'm thinking the near-term environment for oil looks incredibly weak.
One way to play this is to short producers, especially US shale companies that may go bankrupt due to high debt and high production costs. Another way to play it might be to short BNO.
Unlike gold ETFs that hold physical gold, oil ETFs like USO hold no physical oil. The way USO works is that it holds contracts for delivery of physical oil next month (in this case, contracts for delivery on May 20). Then, on the 20th of the month, it sells those contracts and uses the proceeds to buy contracts for delivery the following month (in this case, contracts for delivery on June 20). Ordinarily this works just fine, because the volume in USO is typically pretty low and there are usually plenty of real oil buyers out there willing to pick up USO's contracts on the 20th and take delivery of the physical oil.
Lately, however, speculators have been putting billions of dollars into USO. So today, as it rolled over to next month's contracts, USO dumped all those billions of dollars of May 20 delivery contracts onto a market with very few real oil buyers willing to take May 20 delivery of physical oil.
USO's Brent oil counterpart BNO works the same way and has been getting similar inflows from speculators. My understanding is that Brent oil delivery contracts roll over on the 29th of the month, so a similar meltdown may be coming in Brent oil on April 29.
Also, after today's meltdown we may see some of the demand from speculators go away, and the price of oil stay down at a level that reflects the actual demand from people and companies with licenses to take physical delivery. Added to all of this are the problems that the world's oil storage space is filling up fast, and the reopening of the economy in June is likely to encounter lots of logistical bottlenecks that may slow down the return of oil demand. So I'm thinking the near-term environment for oil looks incredibly weak.
One way to play this is to short producers, especially US shale companies that may go bankrupt due to high debt and high production costs. Another way to play it might be to short BNO.
Note
Word on the street this morning is that although there's still some empty storage space left, it's nearly all already sold.Note
It actually looks like the BNO fund has already rolled over, so this won't happen in BNO on the 29th. Fund managers also took steps this morning to make sure this doesn't happen again next month: they limited the creation of new baskets of contracts in order to prevent another massive dump of contracts. So for the moment, the problem seems resolved.Note
Okay, so after some discussion in the comments where more seasoned oil traders are educating me a little about the futures market, I've concluded that it wasn't USO's rollover that triggered this. USO rolled over earlier in the month. What triggered it was the April 21 expiry date for the WTI futures contract for May delivery. Speculators apparently dumped these contracts on the market a day before expiry. Since the Brent contracts expire on April 30, we still could see similar action in Brent ahead of its expiry date. (In fact, we probably already are seeing that with Brent's price movement today.)It's difficult to know how to play this, however. Oil and gas stocks aren't dropping the way you'd expect them to, because they're being supported by talk of federal bailout money. And BNO doesn't hold May contracts, so there's no way to directly short either the May Brent contract or the Brent spot price. However, it's likely that a downturn in the spot price will affect the June contract price held by BNO, as we've already seen today. So perhaps you could still profit from this by shorting BNO.
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The information and publications are not meant to be, and do not constitute, financial, investment, trading, or other types of advice or recommendations supplied or endorsed by TradingView. Read more in the Terms of Use.