April, 2020 – In the midst of the coronavirus pandemic and on top of historic stock losses, investors were hit with another record-breaking “first”: West Texas Intermediate (WTI) crude futures went negative. For the lay person not familiar with the oil futures market, this probably makes little sense. Here’s an analogy to help:
Imagine you paid for 1000 pounds of birdseed at $1 per pound that would be delivered on the first of the month. Before the birdseed arrives, though, you plan to sell the seed to a garden store for $1.25 per pound. (You don’t really want the seed yourself).
Now, imagine that there’s a birdseed crash and stores don’t want to buy your seed – their bins and aisles are already full. A truck is going to show up to dump 1000 pounds of seed on your driveway if you don’t re-direct it before the 1st. At best, you’ll sell your seed at a loss, at worst, you might have to pay even more for someone to take it off your hands or store it for you.
This is what happened in April 2020 with oil: Speculators that don’t have their own storage capacity paid storage facilities and large refineries who had space (but no demand) to take oil off their hands before it showed up on their driveway. This is good for those storage companies, but terrible for the investor.
Volatility And the Main Street Investor
April is not just a one time “bad break” for investors – trading in oil futures is a risky and complicated investment vehicle best left to institutional and professional traders. Consider the following volatile history of oil:
- In the 1970s, unrest in the Middle East drove crude oil prices from $20-30 per barrel to $120 (adjusted for inflation).
- Prices stayed at these historic highs until the mid-1980s when efforts at fuel efficiency finally balanced out demand and prices remained between $10-25 per barrel through the 1990s (not including a minor spike in prices during the first Gulf War).
- In the mid 2000s, China’s growing economy drove demand and prices to nearly $150 per barrel, only to crash again in the financial crisis of 2008-9.
- The last 10 years have seen prices per barrel range from ~$113 in 2012 to $62 in Feb of 2020, to April 2020’s low of -$38
The most important takeaway is that these wild swings are usually driven by politics and global players far beyond the capacity of an everyday investor to follow, much less anticipate and plan against.
If your financial advisor has recommended investing in oil futures products, such as the USO ETF without discussing the risks, then they may be putting their own interests ahead of yours. If you are a typical investor who has requested a low-risk portfolio and find yourself heavily invested, or overconcentrated, in the high-risk oil industry, then you may have a claim against them.