Biggest Oil ETF Could Go ‘Lights Out,’ Warns Wall Street Strategist(bloomberg.com)
bloomberg.com
Biggest Oil ETF Could Go ‘Lights Out,’ Warns Wall Street Strategist
https://www.bloomberg.com/news/articles/2020-04-21/charlie-mcelligott-worries-biggest-oil-etf-could-go-lights-out
60 comments
All ETFs are a kind of bet ok some real-world good. (on virtual too? Now I'm not sure)
No bet has good/amazing returns if there's no risk. No matter how remote it is, to be safe you sacrifice some profit. When you don't protect yourself for those remote risks, _if_ they bite you, it hurts real bad.
No bet has good/amazing returns if there's no risk. No matter how remote it is, to be safe you sacrifice some profit. When you don't protect yourself for those remote risks, _if_ they bite you, it hurts real bad.
Totally! My understanding of the current situation is that the market wanting more oil has shrunk considerably. Investors were stuck with the chance of having to actually receive the oil they had contracts on, and did all that they could to get rid of it. This compounded and squeezed the price so low.
I'm not sure how many people planned for oil to ever go under zero. I think that many people are going to be eyeing the current storage level (and consumption!) and deciding that the risk (and cost) of having to settle a shipment might not be worth it. But I don't really know ¯\_(ツ)_/¯
I'm not sure how many people planned for oil to ever go under zero. I think that many people are going to be eyeing the current storage level (and consumption!) and deciding that the risk (and cost) of having to settle a shipment might not be worth it. But I don't really know ¯\_(ツ)_/¯
Where can you see storage level?
In the US, the EIA provides info on stockpiles:
https://www.eia.gov/petroleum/supply/weekly/pdf/table1.pdf
But in terms of total capacity, it's tricky, because you can turn the tankers that currently transport oil into floating stores, convert water tanks, salt mines, and other storage media into petroleum storage, etc.
We're probably at about 60% capacity or so here in the US, we haven't even filled up the SPR yet.
https://www.eia.gov/petroleum/supply/weekly/pdf/table1.pdf
But in terms of total capacity, it's tricky, because you can turn the tankers that currently transport oil into floating stores, convert water tanks, salt mines, and other storage media into petroleum storage, etc.
We're probably at about 60% capacity or so here in the US, we haven't even filled up the SPR yet.
Help me understand. How does hitting 60% storage capacity result in negative barrel prices? Shouldn’t that be a 99% scenario?
The price of the oil is based on what someone is willing to pay for it (QED.)
Right now, nobody wants to buy the oil to actually use it.
So the only buyers are people who are willing to store it now, in order to sell it later when the price is better.
Those people are "pricing in" their costs to store the oil in what they're willing to pay for it on the spot market.
As storage becomes more expensive to procure (demand for it is rising, all the "cheap hotels" are sold out, etc.), the price for oil goes down further to cover those costs of storage for it.
Ultimately, the negative prices are a reflection that nobody wants that oil now, and the more negative, the more a reflection that nobody is going to want that oil for awhile.
So the price of oil at the moment is a function of time (how long no one will want the oil) and the available supply (and therefore price) of storage for the period of time when no one wants the oil.
Right now, nobody wants to buy the oil to actually use it.
So the only buyers are people who are willing to store it now, in order to sell it later when the price is better.
Those people are "pricing in" their costs to store the oil in what they're willing to pay for it on the spot market.
As storage becomes more expensive to procure (demand for it is rising, all the "cheap hotels" are sold out, etc.), the price for oil goes down further to cover those costs of storage for it.
Ultimately, the negative prices are a reflection that nobody wants that oil now, and the more negative, the more a reflection that nobody is going to want that oil for awhile.
So the price of oil at the moment is a function of time (how long no one will want the oil) and the available supply (and therefore price) of storage for the period of time when no one wants the oil.
The capacity is mainly for new oil not for the trading of it.
The capacity is already "purchased", so even though it's available from a physical point of view, from a monetary one you need to pay a lot. That amount you need to pay to rent storage is the cause of the negative barrel prices.
https://www.eia.gov/dnav/pet/pet_stoc_wstk_dcu_YCUOK_w.htm is relevant (but doesn't show the actual capacity limits).
https://www.eia.gov/petroleum/storagecapacity/ mentions the actual capacity limits from last September.
It sounds like Cushing, Oklahoma, had 76,093 thousand barrels of total storage and 59,641 of them were used last week. But that's been increasing sharply and might be much closer to the total right now.
59,641 thousand barrels isn't the highest amount that's ever been stored there, but it's getting close:
https://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=W...
I don't know how to get more current data, but I just found this through some web searches, so I bet there's much more information available.
https://www.eia.gov/petroleum/storagecapacity/ mentions the actual capacity limits from last September.
It sounds like Cushing, Oklahoma, had 76,093 thousand barrels of total storage and 59,641 of them were used last week. But that's been increasing sharply and might be much closer to the total right now.
59,641 thousand barrels isn't the highest amount that's ever been stored there, but it's getting close:
https://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=W...
I don't know how to get more current data, but I just found this through some web searches, so I bet there's much more information available.
Would $USL be a better investment? I've noticed it tracks with the price of oil much more closely and only has to renew 1/12 of its contracts every month. I thought it would better bet for something to hold onto for a year or two and then sell when oil goes back up.
It’s a $10 now, yea maybe it’s goes to $20 in a year but with the stockpile now, I don’t see $30 happening again soon. Not a year soon anyhow. But I have no idea, I’d happily defer to others on this.
A 100% return in a year is an amazing return on investment in my book (if you can stomach investing in fossil fuels)
> An exchange-traded fund has not and cannot trade below zero
But why not, and is this baked into the contract? These aren't stocks, where the worst case is a piece of useless paper: if there's no demand for oil, suddenly you're holding barrels of toxic waste with real storage costs, and it makes total sense to pay people to take them off your hands (as has already happened with short-term oil futures).
And the interesting thing is that it's actually in the fund's best interest to allow negative valuations, because that way they're not left holding the bag. I see lots of interesting litigation ahead...
But why not, and is this baked into the contract? These aren't stocks, where the worst case is a piece of useless paper: if there's no demand for oil, suddenly you're holding barrels of toxic waste with real storage costs, and it makes total sense to pay people to take them off your hands (as has already happened with short-term oil futures).
And the interesting thing is that it's actually in the fund's best interest to allow negative valuations, because that way they're not left holding the bag. I see lots of interesting litigation ahead...
> if there's no demand for oil, suddenly you're holding barrels of toxic waste with real storage costs
Thing is ETFs like USO are created specifically to not take physical delivery of the oil. It wouldn't hold any May expiring contracts by design, and is already shifting out its June contracts. If suddenly every single contract for July, August and beyond went negative, and the fund didn't have enough cash to weather it, it would declare bankruptcy. That doesn't actually need this specific situation to happen. For example buying a contract at $100 and selling at $50 would have the same net effect for the fund as buying at $20 and selling at -$30.
There is no additional liability for the investors beyond the piece of paper they are holding (which is not a contract for oil delivery) becoming worthless, which is why zero is the hard floor.
Thing is ETFs like USO are created specifically to not take physical delivery of the oil. It wouldn't hold any May expiring contracts by design, and is already shifting out its June contracts. If suddenly every single contract for July, August and beyond went negative, and the fund didn't have enough cash to weather it, it would declare bankruptcy. That doesn't actually need this specific situation to happen. For example buying a contract at $100 and selling at $50 would have the same net effect for the fund as buying at $20 and selling at -$30.
There is no additional liability for the investors beyond the piece of paper they are holding (which is not a contract for oil delivery) becoming worthless, which is why zero is the hard floor.
What does that paper represent if not a contract for oil delivery? Presumably there's some real world oil backing it, and if so, where does that oil go?
The piece of paper a USO investor holds is shares in the fund. The fund itself holds the futures that are contracts for oil delivery. Limited liability protects the fund's shareholders.
So if the fund declares bankruptcy, who has to deal with the oil?
The contracts will be liquidated first, if possible. If the fund is still left holding some then the exchange and market makers will absorb the losses with their excess capital and insurance policies.
It takes special clearance to even trade contracts that are physically settled. Most of the time these contracts are just cash-settled instead.
It takes special clearance to even trade contracts that are physically settled. Most of the time these contracts are just cash-settled instead.
You own shares of the fund. Imagine it's like a company that makes a bad decision and loses all of its money. Maybe it ends up with debts greater than its assets.
Either way, you as an investor lost the entire value of your shares which are now worthless, so $0 is as low as your investment can go. You're not responsible for paying any of the company's debts if they exist.
Either way, you as an investor lost the entire value of your shares which are now worthless, so $0 is as low as your investment can go. You're not responsible for paying any of the company's debts if they exist.
Think of it this way - if you owned a share of Microsoft stock, and Microsoft suddenly owed someone a trillion dollars, you personally wouldn't be on the hook to pay it.
>And the interesting thing is that it's actually in the fund's best interest to allow negative valuations, because that way they're not left holding the bag
Why would the fund care? They're a separate entity from the company managing the fund. If it goes negative with no hope of going back up, it will go into liquidation like any other company. The ones left holding the bag are the counterparties to those derivatives, not the investors or the company managing the fund.
Why would the fund care? They're a separate entity from the company managing the fund. If it goes negative with no hope of going back up, it will go into liquidation like any other company. The ones left holding the bag are the counterparties to those derivatives, not the investors or the company managing the fund.
If I own shares of an ETF that suddenly has net negative asset value, are they going to send me a bill like a margin call? Good luck with that.
Equity in a limited liability corporation incurs the holder no liability.
The fund isn’t structured as an LLC it’s a limited partnership.
Same difference.
Not for the general partner(s) who have unlimited liability for the entity’s obligations.
On a tangential note: https://robintrack.net/symbol/USO
Looks like the main losers are going to be retail investors.
Looks like the main losers are going to be retail investors.
Assuming it does go under, otherwise quite the opposite. It will be interesting to see what happens. 180K users isn't really even that high, the volume in the ETF is much much much higher. We don't know the dollar amounts people are putting in $1000 for a small gamble is nothing for the size of the ETF.
My personal opinion is that oil will likely reclaim $20 soon, simply because there are so many shorts, so reality won't matter. As to whether USO tracks that, who knows. It didn't today.
My personal opinion is that oil will likely reclaim $20 soon, simply because there are so many shorts, so reality won't matter. As to whether USO tracks that, who knows. It didn't today.
So, what's actually going on in this chart? Are people mass buying this fund as its price drops and hoping for a rebound?
Right. It's also a signal that retail investors don't have much of an impact on anything.
Didn't Credit Suisse loose like half a bil when they shuttered XIV? I feel like the ripple effects of USO going under would be widely felt beyond the retail investors who actually hold any USO in their portfolio.
If you're the USO fund manager right now you are sweating bullets.
There is a massive liability mismatch here. The fund could go negative and leave the fund management company with a massive hole in its pocket and cause it to go bankrupt. I would be worried about all the other ETFs managed by USCF - as they have a high probability of going lights out as well.
On the other hand, investors in USO, no matter their losses, are floored at $0.
Only took an 8-standard deviation event (aka pandemic) for the unthinkable to happen.
There is a massive liability mismatch here. The fund could go negative and leave the fund management company with a massive hole in its pocket and cause it to go bankrupt. I would be worried about all the other ETFs managed by USCF - as they have a high probability of going lights out as well.
On the other hand, investors in USO, no matter their losses, are floored at $0.
Only took an 8-standard deviation event (aka pandemic) for the unthinkable to happen.
You don't "invest in USO" with the expectation of returns. You trade USO or derivatives with the expectation that its price will track movements in oil. Has USO failed to track movements in oil? Will it?
That's right. USO is a derivative on a derivative on commodity that nobody wants right now. The amount of indirection to get from USO to crude would tell me yes, it's failed to reach its stated goal.
What?
The price of oil has fallen sharply. USO has fallen sharply. This is what USO is supposed to do.
The service USO is providing is giving traders a symbol they can use to be directionally exposed to oil without personally maintaining a tricky futures position.
The price of oil has fallen sharply. USO has fallen sharply. This is what USO is supposed to do.
The service USO is providing is giving traders a symbol they can use to be directionally exposed to oil without personally maintaining a tricky futures position.
>Only took an 8-standard deviation event
I'm assuming that it's only 8-standard deviations if you assume a Gaussian distribution.
Wittgenstein’s Ruler (Nassim Taleb) suggests that it's overwhelming likely that the correct distribution is more fat-tailed than Gaussian.
>When someone tells you it was a 10 sigma event, meaning it is 10 standard deviations and it is Gaussian; unless the information came from God, you can reject the Gaussian distribution for that domain. We show the derivations.
https://nassimtaleb.org/2019/07/wittgensteins-ruler/
I'm assuming that it's only 8-standard deviations if you assume a Gaussian distribution.
Wittgenstein’s Ruler (Nassim Taleb) suggests that it's overwhelming likely that the correct distribution is more fat-tailed than Gaussian.
>When someone tells you it was a 10 sigma event, meaning it is 10 standard deviations and it is Gaussian; unless the information came from God, you can reject the Gaussian distribution for that domain. We show the derivations.
https://nassimtaleb.org/2019/07/wittgensteins-ruler/
This is a very common response to any comment about standard deviations and the market. Turns out gaussian modeling is very easy to understand and to use in most cases. If you're trading intraday, that kind of model is probably fine and a great way to build a baseline. If you're changing your time horizon to days or months of years, then something other than gaussian could be of service. IMHO
We are watching large energy companies consolidating US production like other regions in the world ( Mexico, KSA, Iran, RUS ).
The frackers were causing problems in the global oil market.
New technologies normally get consolidated by the larger monopolies over time.
The only way to do it is to bankrupt the smaller players.
The frackers were causing problems in the global oil market.
New technologies normally get consolidated by the larger monopolies over time.
The only way to do it is to bankrupt the smaller players.
Consolidation involves mergers, not bankruptcies. I agree that frackers were causing problems for the oil market, but this isn't consolidation, it's OPEC trying to drive the frackers of of business, maybe even make the US a net importer again and regain some political clout.
You Americans think everything revolves around you.
China is the largest crude oil importer, soon to be the largest total consumer, OPEC cares much more what happens in the East, Europe and partially US.
Covid-19 and the economic crash is a wet dream for the major powers.
- CCP rounded up all the people in HK.
- KSA gets to consolidate market share, steal from middle class through the Aramco IPO.
- British people stopped talking about Brexit.
- Energy cartel in NA continue to vertically integrate after "startup" did their innovation.
Remember that OPEC was Kissinger's idea.
China is the largest crude oil importer, soon to be the largest total consumer, OPEC cares much more what happens in the East, Europe and partially US.
Covid-19 and the economic crash is a wet dream for the major powers.
- CCP rounded up all the people in HK.
- KSA gets to consolidate market share, steal from middle class through the Aramco IPO.
- British people stopped talking about Brexit.
- Energy cartel in NA continue to vertically integrate after "startup" did their innovation.
Remember that OPEC was Kissinger's idea.
Somewhat tangential question: why can't oil producers "buy" these negative contracts and pump the oil back into their wells?
> pump the oil back into their wells
That's...not how oil wells work.
That's...not how oil wells work.
Or just not extract them?
Its V expensive to start and stop production. And there's some tragedy of the commons at play here too. Lots of Texas oil producers are heavily leveraged with debt. With lower prices they have to pump more to meet any obligations they have.
I think the idea that is that it also costs money to shut a well down. Like if you just turn it off, there will be more work to do later when you want to get it back up again. Not just staff, but well / drill / pump / seal / geological issues.
If ETFs get too low (as they often do), they generally do a reverse split. The objective of the fund managers is to track percentage moves - that's all.
USO is doing a 8-1 reverse split next week.
Can someone explain to an newbie like me why supply has not matched demand? Is this the result of contacts to buy oil that predated the price crash?
The Saudis launched a price war just as the coronavirus struck and ramped up production to try and squeeze Russia and/or American shale producers (depending on who you ask). Like most people, they had no idea how hard the virus was going to tank demand and so we ended up with a huge oversupply. Supposedly Trump brokered a deal to get everyone to cut production, but that doesn’t kick in until May 1st.
I just wonder, what % chance is there of lights out? Because if it's only a 30% chance that that'll happen, then doesn't that mean a 70% chance of it coming back up, quadrupling in price in the next year?
Seeing that the OPEC production cuts don't go into effect until the 1st, what would actually happen to this oil if nobody could legally buy it due to lack of storage?
Physically? Eventually all the containers would be full, then the pipelines would back up, then the ships would be full and lack any place to unload, then the loading terminals at oil producing countries would be full, then their pipelines would be full, then finally any buffer at the well head would be full, and ultimately the well owners would be forced to stop pumping or else place the oil somewhere other than into the system (on the ground or into the sky by burning it).
Any idea how quickly a well can “stop pumping”? Is it as easy as the push of a button (I kind of doubt it) or as complex as needing a week or longer?
Depends on the kind of well. Most of them can stop and start easily enough.
But some, once you stop them, they won't start back up again, and will be abandoned. (The oil will harden, and there's no way to heat it back up.)
But some, once you stop them, they won't start back up again, and will be abandoned. (The oil will harden, and there's no way to heat it back up.)
Trump made it legal to dump it anywhere.
Unfortunately with tdameritrade halting trading on oil futures, there are fewer options for retail investors to bet on oil at the moment.
At this point oil stores are reaching maximum capacity, with any free space going for a premium. I think that the squeeze at the end of the month has shown to a lot of people that if you don't have storage room for oil, its a liability.
Good for you if you have a ton of empty storage though!