By: Spencer Israel
On April 20, crude oil went negative. The spot price of a West Texas Intermediate (WTI) futures contract settled at -$37.63/barrel, shattering the previous all-time low of $9.75 set in April 1986. A mess of factors—near-term contract expiration, global oversupply, lack of demand, lack of storage—combined to make the historic collapse happen.
On that same day, Google searches for “How to buy oil” skyrocketed to an all-time high.
Source: Google Trends
The United States Oil Fund (USO) is down 81% in 2020, with much of the damage occurring in April.
In April, USO took in $3.76 billion in new assets as demand for the exchange traded product reached a fever pitch. In all, commodity ETFs—buoyed largely by USO and the SPDR Gold Trust (GLD)—took in a record $14 billion in assets in April.
Investor demand for USO has been so over the top that USCF has been forced to temporarily suspend creations for the fund. Until the SEC grants approval for the provider to issue more shares, the fund will trade at a premium to its NAV.
Oil Goes Down, Interest Goes Up
It’s a juxtaposition lacking in financial logic but rooted in human behavior. As the world’s most important commodity has tanked to historic lows, interest has skyrocketed in the two most popular ways to gain direct exposure. Much of this has been driven by retail investors enticed to buy the dip without understanding the underlying fundamentals in both oil and the USO.
But those “buy the dippers” have been met with mixed results.
Thanks to the collapse in oil and the fear that what happened to the May WTI contracts could happen again, United States Commodities Funds has had to make a number of fundamental changes to the structure of USO, including extending its exposure to as far out as June 2021, moving up the monthly contract rollover period to earlier in the month, and investing in other types of oil.
Despite making those changes, USO is down 19% since April 20. June WTI futures, on the other hand, are up a cool 230% since bottoming at on April 21, apparently buoyed by hopes of economic reopening, while July, August, and September WTI futures are all down approximately 12% in that span.
Meanwhile, the performance of the three largest oil and gas companies in the world, Exxon Mobil, Royal Dutch Shell, and Chevron, have completely disconnected from spot crude prices, and are trading more in-line with the price of July, August, and September WTI futures.
Since the chaos in oil markets hit critical mass on April 20, shares of Exxon Mobil and Chevron are both up around 10%. Royal Dutch Shell was up with its peers but has since declined after cutting its dividend for the first time since World War II.
The point is, buying the dip sounds good in theory, but does not always work in reality. The investors who have flooded into USO in the last few weeks have surely been disappointed, as the fund has continued dropping to all-time lows.
With the global oil market still broken, there is a very real concern that this dance could repeat itself in May. Companies like Diamond Offshore and Whiting Petroleum have already filed for bankruptcy, with more to come. Oil is facing an Armageddon, and until the supply and demand fundamentals get fixed, investors looking to make a quick buck in oil will likely get cut by this falling knife.
The author is long Exxon Mobil and Chevron in his retirement accounts.
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