Is it pump or dump? What next for the oil price
The big news of the week is the price of oil. Crude oil is most commonly sold as a futures contract, and the futures contract for May closed in negative territory, for the first time in history. Looking ahead, the June contract for US crude oil, also known as WTI, is trading down some 80% this week at $11.80 at the time of writing. It also appears to be in free-fall and could easily plunge into negative territory if the selling intensifies once again.
What futures prices tell us about the price of oil today
Looking further along the WTI futures curve, the July future is down some 60% so far this week at $20.20 per barrel, although there has been a stronger bounce back in prices further out the curve, with prices for the August 2020 contract up nearly 10% on Wednesday. However, even with this mini bounce, the price of WTI still looks precarious, and futures contracts all the way out to June 2021 have fallen sharply this week. This price action is telling us that oil is definitely not in vogue, and with coronavirus still raging and a vaccine unlikely to be ready for many months this will trigger unprecedented levels of economic uncertainty. Since the oil price is highly correlated with the global economy, we believe that the oil price is unlikely to experience a recovery any time soon.
The oil price and the FTSE 100
The FTSE 100 has a significant energy sector, so it is worth looking at its performance in the coming weeks and months as the fate of the oil price is likely to be reflected, to some extent, in the UK stock market index. Considering we are bearish on the outlook for the oil price, based on futures prices until at least the end of the year, we believe that the energy sector could be a prolonged drag on the FTSE 100 in the coming months. However, beware trading oil companies’ stocks based on the oil price alone. A quick look at the charts for BP, Shell and Exxon Mobil, show that even though the price of these companies have plunged so far this year, the nadir for their share prices looks to have been around mid-late March. Oil companies have seen a more range-bound price environment in recent weeks, and actually started to recover on Tuesday at the same time as the WTI futures contract for May closed in negative territory. This is due to a number of factors:
· Stocks and commodities have different underlying drivers and trade in different ways.
· Stocks are governed by overall market sentiment, and due to the prevalence of index trackers in the market, when an index rises then a substantial number of passive funds need to buy all of the component parts, which will include energy stocks. This is one of the reasons why energy stocks can trade independently of energy prices.
· Energy firms are often massive conglomorates that have multiple business strands, thus the impact of the decline in the price of oil may only be felt in one unit and could be neutralised by a brighter future for another unit.
· Overall, energy stocks may recover in the long term (say 12 months+), as historically cheap oil could make a switch to cleaner fuel alternatives less attractive.
Why oil could trade under $10 per barrel this year
Thus, while we believe that the price of oil is likely to be compromised for some time, we will be watching the June and July futures contracts for WTI to get some idea if the panic in the oil price is coming to an end or not. If the market pushes the June futures contract into negative territory then we could see oil trading below $10 per barrel in the future. Also, the CDC in the US has warned of an even deadlier second wave of the coronavirus this winter. If this causes a prolonged or secondary lockdown across the world, then we doubt that oil prices will be able to engage in a sustained recovery until the coronavirus threat has passed and economic activity across the world can return to some sort of normal. Thus, the best strategy when trading oil at the moment is to have a very short-term trading strategy and to keep your eye on the futures curve.
What is going on with Brent crude oil?
The price of Brent crude oil has not fallen to the same degree as WTI, the benchmark for Brent is trading at $20.43 per barrel, while the benchmark for WTI is trading at $13.60 per barrel. Why the difference? This is due to the following factors: 1, Brent has historically traded at a premium to WTI as Brent crude is considered to be better quality, 2, The US shale industry has grown exponentially over recent years, at the same time as North sea oil production, which is linked to the Brent price, has contracted, so there is more WTI around, which is also weighing on its price. Lastly, the way that the WTI and Brent contracts work is different – with WTI you need to collect the oil from Cushing in Oklahoma, whereas Brent crude is usually settled in cash, thus, there is less of a storage crunch when Brent futures contracts expire.
We hope that this has gone some way to help you understand how the oil futures market works and also to understand where the oil price could go next. Please read on to see our timeline of what caused the oil price to crash into negative territory.