The sun sets behind a crude oil pump jack on a drill pad in the Permian Basin in Loving County, Texas, U.S. November 24, 2019.
Angus Mordant | Reuters
Stay-at-home orders aren’t only hitting mom-and-pop businesses. They’re also a driver behind the cratering price of oil.
For example, the cost of a futures contract for June deliveries of West Texas Intermediate crude oil was $13.91 per barrel on Wednesday. The so-called WTI is the U.S. benchmark for oil prices.
Meanwhile, the global benchmark for oil costs – Brent crude – is now $20.28 per barrel for June deliveries. Both WTI and Brent are down by roughly 70% year to date.
“Very simply, 3.6 billion people around the world right now are covered by lockdowns,” said Pavel Molchanov, an energy analyst at Raymond James. “We estimate that a fifth of the world’s normal level of oil demand is currently offline because of the lockdowns and economic and travel disruptions.”
In the U.S., where the cost of oil hit negative territory on Monday, fluctuations in oil prices also reflect the fact that we’re running out of room to store it, said Nathan Parker, senior investment research analyst at Commonwealth Financial Network.
“The negative pricing illustrates how storage capacity for oil is expected to be full,” he said. “There are estimates that storage capacity could be full in the next couple of weeks.”
Enter ‘contango’
An employee of a gas station adjusts gasoline pump prices as they continue to fall with the oil market in turmoil on April 21, 2020, in Arlington, Virginia.
Olivier Douliery | AFP | Getty Images
Futures contracts – including futures contracts for oil – are an agreement to buy or sell a commodity at a future date at a specified price.
You can buy a contract that’s as early as one month ahead or as far into the future as a year or beyond.
Under normal circumstances, the current price of the asset is higher than buying the asset far into the future. This is known as “backwardation.”
“Historically for oil at least, we’ve seen more backwardation, but the pandemic is affecting everything right now,” said Molchanov.
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The opposite of this is known as “contango”: That’s when buying the asset far into the future costs more than purchasing it now, and it’s effectively what we’re seeing in oil today.
For instance, the cost of Brent crude for June 2020 deliveries is around $20, but the cost for June 2021 deliveries is $36.18, according to data from CME Group.
“Nobody knows when it will end, but it’s safe to say that the effect of these lockdowns will be smaller six months from now and even smaller a year from now,” Molchanov said. “That’s sending the signal that prices will be higher in the future.”
For retail investors
Most retail investors aren’t readily trading oil futures contracts on their own.
But they can still feel the impact of reeling oil prices if they hold certain exchange-traded funds or exchange-traded notes that invest in these products, said Parker.
On the other hand, individuals who are more broadly diversified in the stock market might be insulated from the gyrations in oil. “Energy is only 3% of the S&P 500 index,” said Molchanov. “If you have a diversified portfolio, the impact won’t be significant at all.”
The winners who’ve ultimately come out ahead from plummeting oil prices are drivers, who are enjoying lower fuel costs.
The national average cost of a gallon of gas is now $1.80, more than a dollar cheaper than a year ago, according to AAA. Few will be able to take advantage of those falling costs, since stay-at-home orders remain in effect for many.