hello YouTube welcome back to my channel my name is Patrick Boyle and this is
Patrick Boyle on finance and today's video is a little bit different to my
usual videos in that I've just really received a lot of questions about what's
going on in the futures market today and I put up all these videos explaining
financial derivatives to people and so I thought I'd give a quick update on
what's going on so it's April 20th today 2020 April 28th of course being Elon
Musk's favorite date but what's happened today is that oil futures the may oil
futures contract has fallen into negative territory so let me explain
what that means okay so this is the first time in history that that the oil
futures have traded in negative territory and this is also the largest
fall in price on record going back to 1983 and so what's happening exactly a
lot of people have been joking that they should run out to the petrol station and
fill up their car for for free or be paid to fill up their car well that
that's not actually what's happening but it's fairly close to that at least in
idea so today the June contract the one that
are expiring next month is a $20 and three cents a barrel at least as of the
time of recording this video but the may contract fell into a negative price so
the mail contract it's worth noting expires tomorrow at the close of futures
trading we need to just better understand futures financial derivatives
and how they work so we'll start out firstly with the simple idea that we can
all imagine is that there's lots of people out there who want to invest in
oil they want to invest in oil because they might feel that the price is likely
to go up now you can equally bet on the price going down but let's let's work
from the idea of someone who thinks that the price is likely to go up they want
to invest in oil and they basically might want to buy oil today at whatever
price is trading that and hold on to it until the price has
gone up to a level of which they've made a reasonable profit right but that's not
actually how investing in oil works and the reason for that is the oil is messy
it's poisonous it's flammable and it's smelly right so you you can't buy a load
of oil and keep barrels of it in your back garden you can't fill up the
swimming pool with it because your neighbors just are going to complain so
that's not how it works you have to then buy some sort of financial product
that's based upon the price of oil and so the financial instrument you buy will
be a bet on oil prices without the mess right that that's kind of what you're
looking for and you you might want one that you can buy it now as I said and
hold on forever until the price moves to a level that you think is a good level
but that's not actually how these things work and if you want to learn more about
this I have other videos on futures and I also have a video on contango and
backwardation which is kind of what this video is all about but all of these
products all of these investment products that relate to the price of oil
expire because when you're investing in oil unless you actually buy oil and
store it in in a shed somewhere you are buying a financial instrument that is an
agreement where you're going to buy oil physical oil from someone for delivery
at some point in the future at which point you'll pay them and
you're fixing the price right now that's what a futures contract is it's an
agreement to buy something at some point in the future where you're agreeing on
the price today and so of course that date eventually comes about right so
that's what's happening in oil right now where people bought these futures
contracts that expire tomorrow and they will have to take delivery of oil if
they still own those contracts now what people often do in investing in oil or
investing in commodities futures is they buy that what we call the front month
contract and that's the contract that's the next one to expire and that is
usually the more the liquid contract and by liquid I mean
the easiest to buy and sell right and so what you would do if you wanted to own
oil for the very long run you might have bought the may contract and then as time
is going by and it's getting close to expiration like tomorrow you would then
sell that may contract and buy the next contract out which is the June contract
and we called out rolling the futures and so you're constantly buying will say
oh the front month are a near month futures contract and then you hold on to
that up until close to the expiration day at which point you either maybe if
you're done with your trade you you exit for good or if you want to keep it going
you then sell that contract and buy the one that's expiring next so you might be
selling the may contract buying the June contract and then in a month's time
you'll be selling the June contract and buying the July contract now a few of
you are possibly thinking but Patrick don't you know about ETF well I dunno
about ETF but an ETF doesn't you know if you're an ETF fund manager you don't
have a huge storage area filled with oil a big lake of oil that you you store it
in you're still trading these futures right so if you put your money in an ETF
the ETF manager takes that money and uses it to invest in oil futures so
you're kind of still even with ETFs even though that looks like something that
never expires it's still tied to this idea of expiration and so once again an
oil ETF and ETF stands for electronically traded fund for those of
you who haven't heard that term before gives its investors and exposure once
again to a financialized version of oil so it's not actual oil which you have to
store somewhere it's a financial version of oil but of course the financial
version of oil is then backed by this other financial version of oil which is
futures contracts which is backed by actual oil and so that's kind of how
that market works now someone does still has to store the actual oil right
because we're doing all of this financial stuff trading in futures or
ETS but there is someone in the background actually dealing with the oil
in either storing the oil or selling the oil to to someone who needs it to
consume and so that oil that you own in sort of an abstract way through a
financial contract is actually physically out there in the world
somewhere and so when you're rolling the future selling will say the cheap May
one right now a very cheap May one because it's got a negative price and
buying the more expensive June one what you're actually doing in a way is paying
someone to store that oil for a month for you right unless think the the term
that we use in in finance for for the difference in the prices is contango and
as I mentioned I have another video that I'll link to in the description that
explains contango in greater detail if you're interested but essentially
rolling the futures the way they are right now where you're selling cheap
mayil and buying more expensive June oil the difference in the price is kind of
what you're paying someone to store that oil for you now of course someone can do
the opposite of that right they could easily buy the cheap may oil contract
sell the more expensive June one and then receive the oil when the contract
expires store it for a month and then re deliver it to whoever needs it and that
would make a profit for them assuming that they had the ability to store oil
somehow now another way things can work is if the prices aren't always it's not
always lower for the the near delivery than the the longer delivery futures
another way it can work is what we call backwardation and as i mentioned there's
a video on that and that would be where the price of June oil is above the price
of May oil and what that would then mean is that the markets are essentially
saying that they will pay you to take a loyal out of storage because people
really need it now and so usually in in the oil market
in a lot of energy derivatives you see what they call normal backwardation but
that's not always the case so right now what is happening in the oil market well
people do think that oil is valuable because as I mentioned the June contract
is trading at around $20 and people do want to bet on its future price but no
one wants it right now and particular no one wants to own the the contract
expiring tomorrow basically because in this environment with the whole covert
19 lockdown and no one's really using as much oil as they normally do and they
don't really have anywhere to store it so does the May futures contract has
gone negative now what does this desist is this just a financial thing or does
it tell us something about the real world
well financial things always tell us something about the real world and so
what we can see about the real world in these prices that they're kind of
highlighting a fast-growing glut of oil in the world that relates to due to a
number of things such as the price of oil being reduced by Russian Saudi
Arabia but also just the fact that there's really much lower demand right
now for a while then you typically expect simply because of the covert 19
lock down and people aren't driving factories are not all open airplanes
aren't in the air and so on and so less less energy is being used and in
addition it also highlights growing stockpile in the United States a lot of
the oil is stored in Oklahoma and those storages are pretty much full at this
point so what are they calling this well they're calling this super contango
which is of course like contango but but it's super and the June contract is way
above the may contract in terms of prices it's much more contango than you
would normally see and this of course relates to all sorts of signs
of economic weakness and just weirdness in the markets that we're seeing during
this this kovat 19 lockdown in in Texas buyers are offering producers as little
as $2 a barrel for certain streams of oil it's worth noting that very little
oil actually trades at the price that you see in the futures market because of
course different oil comes out of different wells there's different
delivery there's different qualities of oil and so on so the the price that you
see in the newspaper of oil is kind of more of a benchmark price but then the
actual oil trades of different prices based on different deals that been
struck and so on and there is actually the possibility that producers might
soon have to pay someone to take crude oil off of their hands now what does
that mean because that's kind of weird as well and in normal economics you
would think there will be no negative price we couldn't have a negative price
as simply because if someone is is offering it if you have oil and someone
is saying you have to pay me to take it from you you might say well actually
I'll just keep it in the ground oh I'll just hold on to this oil but the oil
market is a little bit different and a little bit more complicated than that
and part of it is just tied to this idea that oil is hard to shut into the ground
like when you've got these wells flowing you can't just sort of turn a tap and
stop um it's it's more difficult from an engineering perspective than then
turning off your your kitchen sink for example and and if you do shut it down
it's difficult to restart an oil well so all of this stuff is kind of playing
into what's going on in the oil market in general a global pandemic like what
we're in right now is just weird for all commodity prices if you have a thing
that lots of people want but nobody wants it right now like like oil it's
very difficult to put a normal price on it and that's what we're seeing in a lot
of the world of commodities and even just in a lot of the world
when we look at stock prices or you know business investments it's very difficult
to put a price on things right now simply because it's it's very difficult
for people to to know what's going to happen going forward so anyhow hopefully
you've found this video a little bit interesting as I mentioned I have other
videos that are linked to please like and subscribe if you found this useful
cuz this is the kind of content I make and do let me know in the comment
section if you'd like more kind of market update type stuff like this
normally I I don't don't really comment on today's market but basically I got a
lot of questions and I thought this would be the easiest way to answer them
so anyhow have a great day guys and talk to you later bye