As expected, yesterday’s negative close on the May futures oil contract for West Texas Intermediate has resulted in some fireworks across markets. While it’s still not entirely clear what specifically caused the massive crash in the price of oil (although theories abound, aside from storage concerns), what is clear is the effect it has had on multiple aspects of the oil market.
For those unaware (although there are likely few who are at this point), oil closed in negative territory on the May futures contract last night for the first time ever, at a price nearing -$40 a barrel. Massive contango was experienced at the time – in short, when future month contracts are priced significantly higher than the current month – however that has now come off significantly as the contract nears closing at the end of today’s session.
With the May contract now nearing its close, the focus has become the June oil futures contract, which experienced a massive fall from grace in the overnight session. The price per barrel fell from $21.34 as low as $11.55 before recovering to a current price of $14.54, which is still a significant drop, but not nearly as bad as it was.
The price action however has had a massive effect on various extrange traded funds and exchange traded notes. For instance, Barclay’s announced late last night already that it would be redeeming its iPath® Series B S&P GSCI® Crude Oil Total Return Index ETN (NYSE: OIL) following the massive fall from grace of oil yesterday. Redemptions will be based on the ETN’s value as of April 23, with full redemption occurring by April 30. Sales and issuance of the ETN were also halted as of April 20.
Holders of the United States Oil Fund (NYSE: USO) fared slightly better, however the creation of new units has been halted until the SEC approves recent filings for more shares. Until new shares are able to be issued, the fund will essentially trade like a closed-end mutual fund rather than a true ETF. This was a result of the fund seeing a surge of retail investors flow into the ETF as they bet that crude will go higher longer term.
What these retail traders fail to understand however is that the ETF is largely focused on the front month contract, with a smaller level of exposure to the second month contract, with an approximate 80/20 split overall. What this means, is that despite the declared $4.1 billion in assets as of last nights market close, that figure has been significantly reduced as a result of this mornings trading. Approximately $2.7 billion in market value of the equity was attributed to the NYMEX WTI Crude Oil CL JUN20 contract as of last night, which was based on a price of $20.43. Effectively 25% of that value has evaporated overnight.
In terms of the NYMEX July contract, for which the fund has $751 million in exposure, the value of that contract has declined 13% overnight – resulting in a significantly reduced net asset value for the fund as of this evenings close if things don’t rebound. Furthermore, if the June contract happens to go negative, it’s unclear how the event will be handled by the exchange, given that the ETF can’t exactly demand further funds from investors to cover the losses like it would from someone trading directly in the future.
This part is significant, because as of yesterday’s close the USO accounted for approximately one third (30%) of the open interest on the June oil contract. As such, the rumour is that the CME might be forced to close out the ETF as a result of the risk presented under such circumstances. Whatever the case may be, future fireworks are certain to occur through this volatility.
Information for this briefing was found via ZeroHedge, MarketWatch and Bloomberg. The author has no securities or affiliations related to any organization discussed. Not a recommendation to buy or sell. Always do additional research and consult a professional before purchasing a security. The author holds no licenses.
