The bizarre reverse oil price for Texas Crude shocked us all. How could it happen and does it reflect reality? Not really. What did happen (and can happen again) is that storage capacity for the stuff is filling-up. This means that when the delivery point arrives, the only way you can dispose of your oil is by paying someone to take it off your hands! This phenomenon won’t last for long. The taps will be turned-off slowly (Russia has just agreed to cut, pushing prices 30% higher on one day) and the supply will shrink. When the world is back to some semblance of normality its 8 billion inhabitants will revert to similar ideas as existed before and consumption will rise significantly. In fact, there could be oil shortages and then rapidly rising prices. I’ll say again what I have said before, a fair equilibrium oil price in my view (recognising there are many types of oil!) is around $70 a barrel.
So, you want to buy cheap oil and you buy an Exchange Traded Fund (ETF) which trades the commodity. Maybe that is a very bad idea. Why? These things hold futures’ contracts. They don’t have vast, expensive storage facilities to keep the oil. So as a contract expiry date approaches, they have to sell to someone who wants physical delivery but at whatever the price, to buy a longer dated future contract. In normal times, this is fine but in these times, it has meant that selling a short-dated contract and buying the next one out sees a dreadful price on what you sell and a high price for what you buy. Whilst usually they don’t trade the nearest month, it could still be the case that your oil ETF loses $20 a barrel each time it has to roll! This pricing anomaly is rare and is called ‘contango’. So, in theory, the future price of the commodity is much more than the present price so if you did have a silo and took delivery of oil, you could sell it immediately for say August delivery for a big fat guaranteed profit. So really, if you think oil is too cheap (which it is) then you are better buying oil shares frankly as otherwise your view could be right but you lose on each technical rolling within your ETF.
