Life Below Zero

“After all, we are dealing with a new normal.”

That’s how I ended my Weekly Column, “Rule #6”, this past weekend, and it rings even truer Monday afternoon following a historic day in the crude oil market. I was on the phone with a customer, a friend, as crude oil fell below $0, with my son and business partner updating me on the whiteboard as the May contract continued to fall. It was like the old days with prices being posted on a chalkboard. It was like the old days pointing us to a new normal.

We answered a question that has been around as long as there has been trade in commodity futures, “Can a market go below $0?” I’ve joked about it many times over the decades, usually making my comment at a time when futures spreads are unimaginably bearish and noncommercial traders piling into short futures positions. This is indeed the case for crude oil, with the May contract set to expire Tuesday (April 21) and the May-July futures spread hitting a carry (contango in New York terms) of almost $60. Yes, you read that correctly. The May contract is priced roughly $60 under the June contract Monday afternoon, something not only never seen before, but never dreamed of as well.

Many in the industry were quick to point out the June contract is a truer reflection of the actual value of the market, sitting at about $21 per barrel Monday afternoon. As I said in Afternoon Commentary, I don’t disagree. It’s like a grain contract in delivery, when all bets (and daily limits) are off. But I also contend the historic path laid out by the May issue could be followed by the June over the next month.

First, all of the domestic demand for WTI is accounted for as the May contract heads into expiration. With tankers full of crude oil headed toward the United States from Saudi Arabia, the situation isn’t suddenly going to solve itself over the next 24 hours, or 24 days. I’ll point out the June-July spread is showing a carry of more than $6 as compared to the May-June’s contango of $1.73 a month ago. Will the June-July collapse as the May-June did? If my Down Escalator Situation plays out again, as it so often does in such market environments, then it isn’t an impossibility. And if the June-July spread collapses it likely means the June contract is melting down once again.

Who, though, is willing to sell at these levels? Funds. Monday afternoon’s conversation quickly turned to long-only funds who are in nearby WTI crude oil futures, and at some point, they will have to sell those contracts and roll to the next contract, in this case, the July. Meanwhile, the commercial side, as discussed above, is likely to keep the pressure on the market because supplies are expected to stay burdensome, and as we talked about in the previous Weekly Column, demand is non-existent. These fundamental factors aren’t expected to change during May, and maybe not June or July. Remember, the WTI forward curve is showing a $13.50 contango from June through March 2021.

A side note: As I like to say, the difference between “fund” and “fundamental” is “a mental” thing.

As I was writing Monday’s Afternoon Commentary, a friend sent me an email stating, “Lease a couple (or fleet) of tanker trucks, but May futures, take delivery, sell June futures now.” I’m no oil expert but listening commentary of those who tell me one has to be in the oil industry to take delivery on crude oil, even if the producer is willing to pay you to do it (negative price). Otherwise, that arbitrage scenario makes sense, and I’ll admit, the same idea crossed my mind as I watched the market unfold.

Within that last statement is a fascinating reality: Producers are willing to pay someone to take supplies off their hands rather than just stop producing. It seems counter-intuitive to me, but then again, I don’t know all the start-up costs involved with getting rigs and refineries running again. And if we take a step back, how close are we to seeing something similar happen in a market we all can relate to, Corn.

In its ridiculous Prospective Plantings report, USDA stated U.S. corn producers were planning on planting 97 million acres (ma), an increase of 7.3 ma (8%) from last year. Even if we discount last year’s washout, the previous PP report release at the end of March 2019 pegged planted acres at 92.8 million, meaning this year’s 97 ma would be an increase of 4.2 ma (4.5%). Now let’s stretch our assumption more and say Mother Nature plays ornery again in 2020, and actually provides good growing and harvest conditions over the rest of the spring, summer, and fall, and U.S. corn production approaches 16 billion bushels. As of now, demand is being destroyed meaning 2020-2021 ending stocks could climb to nearly 3 bb. Could we see new-crop corn go negative?

Probably not, because of the U.S. government’s loan program. Remember Loan Deficiency Payments? As of now the national loan price for corn is $2.20 per bushel, and the cmdty National Corn Price Index (national average cash price) is calculated near $2.86, less than 70 cents away from the loan. It doesn’t take much imagination to picture a scenario with corn falling to or below the national loan price if all these fundamental factors play out.

Finally, I was asked about the difference between the flash crashes we’ve seen in equity markets as opposed to Monday’s move in crude oil. Why did crude oil go below $0 while equities find a stopping point? Demand. There is always a demand for equity markets, and as Newsom’s Market Rule #7 states: Stock markets go up over time. That isn’t true of commodities. Long-term demand markets come and go, with the last major one corn’s ethanol driven market dating back to the fall of 2006. If long-term and lasting demand destruction are being seen in the petroleum industry, and I think it is, could the same be said for corn?

In this new normal, do we simply return to the old days, pre-2006? If so, then the old song was right, “Everything old is new again.”

Until next time,

Darin Newsom