We aren't used to the idea that whole markets can be phony. We certainly aren't used to an instrument that could drive down something as important as the price of oil.
But that's what happened earlier this week when the price of oil plummeted to minus $37 and took the stock market with it.
Now we still don't know what made the price of some commodity that is so important to the entire world go to where you had to pay someone to take it. It is rumored to be because a particular instrument called the United States Oil Fund (USO) , which is a publicly traded commodity pool, wasn't able to get rid of the oil it had to take in because it's charter doesn't even let it own the physical property. So it had to get rid of it no matter what the price and you can see that the price was pretty disastrous.
What matters to me, though is this collapse was not only artificial but it freaked out the entire market.
First, I do not blame anyone from trying to extrapolate the "historic collapse" into a belief that the entire economy must have just stopped. Thursday's "historic rally" back to the mid-teens from minus $37, should show you that perhaps there is something wrong with the futures, not the economy.
Now there is no doubt a lot less demand for oil than before the coronavirus. When there are shelter-in-place orders all over the country, you are not going to get a pick up in use at the pump or at the jet fuel terminals.
But the concept of someone paying someone else $37 to take a barrel of oil has more to do with the malfunctioning of the way the commodity trades, not how it works.
Think of it like this: Every commodity that trades ultimately can be destroyed by the holder, rather than take delivery, except for crude. There are plenty of very smart traders who knew that the USO, again, a stock that represents a commodity pool, got caught owning something it shouldn't be allowed to own. It couldn't find storage because there was no storage to be found and the traditional financial buyers smelled blood and walked away until the final minutes of trading and then the hapless USO let go of its oil because it couldn't stow it or burn it or get rid of it.
When the May contract expired, the USO issue went away and we went back to the usual market. Now the usual is no longer in the thirties or forties, or even the twenties, not just because of demand, but because of what happened earlier this week.
But here's what should give you pause before you extrapolate. Do you know that almost every single oil and gas stock has had a furious rally this week? If that May future contract were actually functioning, rather than just being a plaything for financial traders to take advantage of a broken stock of a broken operator, then these stocks would be crashing left and right. While many of these companies will not be able to make money at these levels, we can at least rest assured that there will not be a mass collapse of an industry that is vital for jobs and for national security.
Now, does that mean it is worth owning these stocks?
I would say that it's a dangerous exercise to do so, and not just because, unless this USO is simply cancelled, what happened earlier this week could happen again, because there's no storage space and none being built of any consequence. Think of it more of a game of musical chairs, with the USO being the odd player out, not of a commodity that every month is worthless.
I would avoid them because almost all of their cost structures are out of whack. They aren't able to shut their wells easily. Many borrowed a lot of money to drill, betting that the price of oil would snap back. Who thought of Covid-19? Sure, a couple have been smart enough to be more prepared for the disaster. Parsley (PE) , EOG Resources (EOG) , Diamondback (FANG) and Chevron (CVX) come to mind. One of the reasons, though, that I have turned forcefully against index funds is that they have to own some oil stocks. I think that money is propping them up beyond where they might be otherwise when we get rallies.
Most important; a manipulated instrument representing no more than a few hundred million dollars brought down an almost trillion dollars' worth of stocks. That's absurd, but it happened. That makes them way too dangerous to own because as long as the USO still exists in its current form, I bet the same crash happens again one month from now.
