Head of Commodity Strategy
Summary: Crude oil continues to trade lower this Monday with the headline grabber being the near 20% collapse overnight in the soon-to-expire May contract (CLK0). Most active traders have by now moved on to focus on the June contract (CLM0) which is the most active now, both in terms of traded volume and open interest.
What is our trading focus?
OILUKJUN20 – Brent Crude Oil
OILUSJUN20 – WTI Crude Oil
CLM0-N0 - WTI June-July Spread
XOP:arcx – Oil & Gas Exploration & Production
XLE:arcx – Energy Select Sector SPDR Fund (Large-cap US energy stocks)
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Crude oil continues to trade lower this Monday with the headline grabber being the near 20% collapse overnight in the soon-to-expire May contract (CLK0). Most active traders have by now moved on to focus on the June contract (CLM0) which is the most active now, both in terms of traded volume and open interest.
The expiring contract is now mostly in the hands of physical oil traders and the behavior of the contract confirms what we already feared: That the U.S. is running out of storage at Cushing, Oklahoma, the delivery hub for WTI crude oil futures traded in New York. The weekly stock report from the Energy information Administration shows how the Covid-19 related lock downs in the U.S. has temporarily killed demand for gasoline. Last week’s report found record levels of gasoline while implied demand had dropped to a record low (since 1992).
As gasoline tanks begin to fill the demand for crude oil drops and this development has increased demand for storage. With storage filling up the price of oil for immediate delivery has tanked. The near 9 dollar spread between May and June is a clear sign that physical oil traders have no space available. It they had they could buy May crude oil, take delivery, store it and then sell it back into the market in June earning a one-month return of close to 60%.
Speculators having bought the June contract now risks that it could get pulled lower over the coming weeks towards where the May is currently trading. Only a major change in the fundamental outlook through lower production, due to producers being forced out of business or leave wells idle, or improved demand for fuel can prevent.
NOTE on oil ETFs: During the past month the largest actively-managed long-only oil-focused ETFs, such as USO:arcx and UCO:arcx boosted their net holdings of crude by more than 400%. These ETF’s are predominantly positioned at the front of the futures curve and will be exposed to rolling losses every month until the market fundamentals eventually stabilizes, and that could take several months. As mentioned the soon to expire WTI May contract (CLK0) trades more than 50% below the June contract (CLM0).
Unless the fundamental outlook changes over the next four weeks the June contract risks the same fate as the expiring May and the drop will be reflected in the price of these ETFs. On that basis we cannot reiterate enough how difficult and potential costly it can be to try to bottom fish “cheap” oil when the fundamentals are this poor as reflected through a very steep contango.
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As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
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