The oil trade on Monday was one for the history books. For the first time in history, oil traded below $0, providing proof the downside risk with commodities is not just $0.
'Part of the problem here was people's models weren't able to work with negative numbers,” says Tommy Grisafi of Advance Trading. “In the last few days, everyone has adjusted their models.”
Some say this is the first time a commodity traded in negative territory, but CME Group CEO Terry Duffy on a CNBC Closing Bell interview this week said that’s simply not true.
“Natural gas has gone negative; we’ve had other crude refined products go negative,” says Duffy. “It’s just wrong to say that.”
As May futures took a nosedive, some traders were caught in a position they couldn’t escape. Interactive Brokers Group issued a statement on margin loss, saying some customers held long positions in CME contracts, and as a result, incurred losses in excess of the equity in their account. The Company said that resulted in a loss of $88 million for the company.
While CME announced earlier that options could trade in the negative price range, some analysts say futures weren’t included in that. However, on Monday, CME said it was now possible for negative price for May futures only. Now there are groups aking for an investigation into Monday's price action in oil. CME responded, saying the market acted as a true function of supply and demand.
“CME Group markets worked as designed,” says a CME Group spokesman. “ Our futures prices reflect fundamentals in the physical crude oil market driven by the unprecedented global impacts of the coronavirus, including decreased demand for crude, global oversupply, and high levels of U.S. storage utilization. After advance notice to our regulator and the marketplace in early April, CME Group accommodated negative futures prices on WTI on April 20 so that clients could manage their risk amid dramatic price moves, while also ensuring the convergence of futures and cash prices. “
As the historic price action unfolded Monday, a striking question started popping: could agriculture commodities be next? Darin Newsom of Darin Newsom Analytics says the short answer is “yes.”
“It has been proven now it can happen to any storable commodity that continues to show increased supplies at a time when demand is being destroyed, an example would be corn,” Newsom says.
Possible, Not Probable
Newsom says it's possible for other commodities to see other commodities, like corn, trade below $0; however, he thinks it’s not probable. He says the reason is demand.
“We saw complete destruction of demand in the crude oil market,” he says. “Nobody is driving. We're not refining anything. Storage facilities, if they're not full, all the storage is spoken for and we have more tankers headed toward the United State with oil right now.
Newsom says for oil, the issue is an oversupply situation, while demand diminished, and that created an extremely bearish scenario. Newsom says while some agriculture commodities could be at risk of a similar scenario, there is still demand for products.
“On the grains, because of food, we still should have demand,” he says. “That is being threatened, and I think the market that's most threatened right now by a demand destruction situation is indeed corn.”
Seth Meyer an economist with the University of Missouri agrees it’s possibly for anything to trade lower, but he thinks the main difference between oil and corn is the ability to store it.
“In theory, I suspect it is possible for both grains and ethanol to ‘go negative’ futures, but I think it is more difficult for grains given wide delivery points and the fact that you can dump it on the ground, you cannot do that with oil storage,” Meyer says. “For ethanol, I think the risk is greater and those folks have been significantly cutting production as storage dries up (there is some play between oil/gas/ethanol storage. So, I think it possible, but highly unlikely given current conditions.”
The ethanol demand picture is bleak, and as a result, ethanol plants are slashing output. Currently, more than 70 ethanol plants have idled production and another 70 have reduced production. Still, ethanol stocks remain at record highs. That’s why the risk may be heavier with ethanol trading down below $0 versus corn trading in negative territory.
“The theory is if it costs more to stop production and restart it at a later date rather than paying someone to take supplies off your hands short-term,” Newsom says. “We’ll see if this happens in new-crop corn and/or soybeans, though $0 in those markets is the government loan prices, or artificial floors.”
Still, Newsom acknowledges the risk of prices falling below $0 is there, even when it comes to key commodities like corn.
“A fascinating reality happened yesterday: producers are willing to pay someone to take supplies off their hands rather than just stop producing,” Newsom says. “It seems counter-intuitive to me, but then again, I don’t know all the start-up costs involved with getting rigs and refineries running again. And if we take a step back, how close are we to seeing something similar happen in a market we all can relate to: corn.”
Grisafi adds that even though something is possible, but nt likely, doesn’t mean you should rule it out.
“Because of COVID-19, because of America shutting down, all things are possible now,” he says. “If you don't believe me, ask the person who was long May crude oil on Monday and where they’re going to come up with that huge sum of money to pay that debit.
Price Negative Trades
After CME announced on Monday oil futures could trade negative, some analysts feared all bets were off and oil could fall lower than ever before. Analysts agree the risk is no longer $0 for commodity prices.
“We now see $0 isn’t just a running joke in commodities, but a reality when supply and demand get completely out of line,” Newsom adds.
How are negative prices possible? Meyer says with oil, it boils down to the fact of no storage and so people were willing to pay to get rid of the product.
“If folks don’t want to take delivery and the cost of taking delivery - storage and transport- it’s greater than the value of the product,” Meyer says. “This is why I think it is more difficult for grains to go negative. I’m not expert, but you can take delivery and dump it in a pile.”
A Repeat in June?
The May contract traded below $0 on Monday, just one day before it was set to expire, while the June contract still posted positive prices. However, Newsom warns a repeat of Monday’s price action could happen again in a month, when the June contract is set to expire and the issue of no available storage is still prevalent.
“Many in the industry were quick to point out the June contract is a truer reflection of the actual value of the market, sitting at about $21 per barrel Monday afternoon,” Newsom adds. “As I said in my ‘Afternoon Commentary’, I don’t disagree. It’s like a grain contract in delivery, when all bets -and daily limits - are off. But I also contend the historic path laid out by the May issue could be followed by the June over the next month.”