Is it true that oil costs nothing now, and you will be paid extra for refuelling your car tank? Unfortunately, no.
Is it true that the situation in the oil market is hard? Yes.
Does it hurt the economies of the largest oil exporters? Yes.
Will it kill them? Fortunately, no.
So, what happened that everyone began to monitor the rapidly falling price of oil on Monday evening? The truth is that it was not the price of oil that was falling. Rather, not exactly the price of oil. That was the cost of futures, an exchange instrument reflecting the price of oil, was plunging and reached the negative zone. And it affected just one type of oil – WTI, American crude oil, West Texas Intermediate. Why did the collapse happen there? Because this contract is special. Usually, such assets are purely speculative (investment) instruments and the people who sell or buy them are not related to real oil supplies. There is simply a bet on the price, whether that’s the high-quality Brent or the Russian Urals.
But the contract for WTI is special. Contracts for this type of oil are traded with physical delivery – for example in Cushing, Oklahoma, where huge oil storage facilities are placed. And now there is a unique technical situation. The futures contract has a certain expiration time. Everyone was watching the May contract, the expiration of which is scheduled for this week. But the trouble is that it is impossible to supply this oil just because the storage facilities are full. This was the result of a trade war in the oil market, which started amid falling demand after the quarantine was announced around the globe. Planes stopped flying, cars drove much less, many industries stopped. And oil producers, in an attempt to squeeze each other out of the market, increased the oil production.
As a result, this contract became impossible to fulfill. And the market players, namely speculators and traders, were trapped. Exactly those players who traded the May contract particularly. And, for sure, they were in full confidence that the contract price can not become negative. But as the practise shows it can, although that was the first precedent in history. The price dropped below zero. And they will have to pay someone to store this oil for the next month somewhere just because the delivery to a point ‘X’ is simply impossible.
The negative cost of oil does not reflect real deals for the purchase and sale of oil, but rather the situation in the exchange with one specific contract tied to delivery in May. For instance, nothing tragic happened with futures with expiration in June. Therefore, only speculators who traded a specific instrument suffered and the trading volume in this instrument was already minimal. Just because the expiration date of this instrument is nearing and almost no one was trading it already.
The next question is about the difference in quotes from different sources. Every provider of spot liquidity in oil derives and constructs their price differently (given there is no actual spot oil product in the market). The principal players in the market provide prices which differ greatly in their construction. These differences are typically between (as close as) an approximation of a live spot price as possible, a synthetic rolling front month future or a synthetic 45-day forward price. Some providers simply provide a price that is derived from the front month future and adjust the full amount of the difference upon the expiry of the front month, which would mean that there would be a price jump of over 100% overnight (at current prices). The absolute difference between these prices will be determined by the forward curve in Oil, meaning the price differential between the spot price and the future expiries of the product. The market is experiencing a severe dislocation at present, which is the reason why the price differentials are so significant.
There is a roughly $12 price between May and June, which means that the disparity between a “spot” oil that is priced as a T+2 product (closer to May expiry than to June expiry) is going to be significantly different to a “spot” oil product that is priced as a T+45 product (halfway between the June and July expiry). Juno Markets oil price is a proprietary price which is designed to provide a smooth rolling spot price feed which minimizes the large price step adjustments that are a feature of the pricing of some of our competitors. We also believe that a price that is derived much further up the oil forward curve is not a spot price, but a forward price. This is clearly the case for providers who are pricing “spot” oil around $23 currently. The calculation to obtain the spot price is derived from the last expired contract (in this case May) and the front-month futures contract (currently June). A daily adjustment is made to the price of the product as we trend closer towards the new front-month contract.
Before trying to forecast the trend direction for the oil market, FX traders should understand the fundamental background as the technical analysis does not work properly in such circumstances. Many traders around the globe already started seeing the light at the end of the tunnel in terms of the quarantine and pandemic nightmare. Many leading economies are about to restart sooner rather than later, which should recover the global demand for oil, at least partially. Refineries will get back to work, lowering inventories in storage facilities. As a result, the price of oil will start getting support from buyers.
The recent situation with the price war between Saudi Arabia and Russia and the following OPEC+ deal to cut the global oil output by an unprecedented volume of 10 million barrels per day was not enough to save the market from the crash. Therefore, possible enlarging of the production cut might have a more significant influence. Nevertheless, such turmoils do not reverse just like that. So it’s hard to expect the oil price to recover quickly. The US Crude Oil Inventories report is extremely important for the trend direction in the nearest future. It was published on Wednesday and the figures show that the oil consumption is far from recovering. The final reading of 15.022 million barrels was slightly better than expected as analysts were predicting 15.150 million barrels. Nevertheless, it was definitely better than the last week’s report of 19.248 million barrels, which caused a weekly decline of 20% for the WTI Crude Oil price.
The long-term monthly chart below shows that the price of oil entered an unknown territory for the technical analysis, at least for the foreseeable past of more than 20 years. April’s candlestick has minimal chances to close the month above the lowest monthly close price since October 2001 ($19.44 per barrel). The price of oil breached the upper median line which used to act as the resistance for three consecutive peaks in 2008-2012. On top of that, the price is heading towards the support line connecting two bottoms charted in 2010 and 2016. Moving averages with periods of 89 and 13 months are very lagging, considering the recent plunge.
The daily timeframe is also extremely bearish but a long shadow of the daily candlestick on Tuesday and the bullish candlestick on Wednesday leave a bit of hope for the bulls. The nearest resistance is in the range of $15.79/16.84 per barrel, according to the Ichimoku Cloud indicator. But the ADX main line is far from peaking, which shows that the bearish momentum is still growing, while the negative surplus between -DI and +DI lines is extremely high.
We recommend FX traders to be very cautious in such a volatile environment and remember about risk management rules, keeping stop-loss and take-profit orders tight and avoiding too much pressure on the account balance. At the same time, traders should not hold their positions for too long and use intraday short-term trading strategy as the market conditions change rapidly nowadays. Let the profit be with us!