hello YouTube welcome back to my channel
my name is Patrick Boyle and this is
Patrick Boyle on finance and today's
video is a little bit different to my
usual videos in that I've just really
received a lot of questions about what's
going on in the futures market today and
I put up all these videos explaining
financial derivatives to people and so I
thought I'd give a quick update on
what's going on so it's April 20th today
2020 April 28th of course being Elon
Musk's favorite date but what's happened
today is that oil futures the may oil
futures contract has fallen into
negative territory so let me explain
what that means okay so this is the
first time in history that that the oil
futures have traded in negative
territory and this is also the largest
fall in price on record going back to
1983 and so what's happening exactly a
lot of people have been joking that they
should run out to the petrol station and
fill up their car for for free or be
paid to fill up their car well that
that's not actually what's happening but
it's fairly close to that at least in
idea
so today the June contract the one that
are expiring next month is a $20 and
three cents a barrel at least as of the
time of recording this video but the may
contract fell into a negative price so
the mail contract it's worth noting
expires tomorrow at the close of futures
trading we need to just better
understand futures financial derivatives
and how they work so we'll start out
firstly with the simple idea that we can
all imagine is that there's lots of
people out there who want to invest in
oil they want to invest in oil because
they might feel that the price is likely
to go up now you can equally bet on the
price going down but let's let's work
from the idea of someone who thinks that
the price is likely to go up they want
to invest in oil and they basically
might want to buy oil today at whatever
price is trading that
and hold on to it until the price has
gone up to a level of which they've made
a reasonable profit right but that's not
actually how investing in oil works and
the reason for that is the oil is messy
it's poisonous it's flammable and it's
smelly right so you you can't buy a load
of oil and keep barrels of it in your
back garden you can't fill up the
swimming pool with it because your
neighbors just are going to complain so
that's not how it works you have to then
buy some sort of financial product
that's based upon the price of oil and
so the financial instrument you buy will
be a bet on oil prices without the mess
right that that's kind of what you're
looking for and you you might want one
that you can buy it now as I said and
hold on forever until the price moves to
a level that you think is a good level
but that's not actually how these things
work and if you want to learn more about
this I have other videos on futures and
I also have a video on contango and
backwardation which is kind of what this
video is all about but all of these
products all of these investment
products that relate to the price of oil
expire because when you're investing in
oil unless you actually buy oil and
store it in in a shed somewhere you are
buying a financial instrument that is an
agreement where you're going to buy oil
physical oil from someone for delivery
at some point in the future
at which point you'll pay them and
you're fixing the price right now that's
what a futures contract is it's an
agreement to buy something at some point
in the future where you're agreeing on
the price today and so of course that
date eventually comes about right so
that's what's happening in oil right now
where people bought these futures
contracts that expire tomorrow and they
will have to take delivery of oil if
they still own those contracts now what
people often do in investing in oil or
investing in commodities futures is they
buy that what we call the front month
contract and that's the contract that's
the next one to expire and that is
usually the more
the liquid contract and by liquid I mean
the easiest to buy and sell right and so
what you would do if you wanted to own
oil for the very long run you might have
bought the may contract and then as time
is going by and it's getting close to
expiration like tomorrow you would then
sell that may contract and buy the next
contract out which is the June contract
and we called out rolling the futures
and so you're constantly buying will say
oh the front month are a near month
futures contract and then you hold on to
that up until close to the expiration
day at which point you either maybe if
you're done with your trade you you exit
for good or if you want to keep it going
you then sell that contract and buy the
one that's expiring next so you might be
selling the may contract buying the June
contract and then in a month's time
you'll be selling the June contract and
buying the July contract now a few of
you are possibly thinking but Patrick
don't you know about ETF well I dunno
about ETF but an ETF doesn't you know if
you're an ETF fund manager you don't
have a huge storage area filled with oil
a big lake of oil that you you store it
in you're still trading these futures
right so if you put your money in an ETF
the ETF manager takes that money and
uses it to invest in oil futures so
you're kind of still even with ETFs even
though that looks like something that
never expires it's still tied to this
idea of expiration and so once again an
oil ETF and ETF stands for
electronically traded fund for those of
you who haven't heard that term before
gives its investors and exposure once
again to a financialized version of oil
so it's not actual oil which you have to
store somewhere it's a financial version
of oil but of course the financial
version of oil is then backed by this
other financial version of oil which is
futures contracts which is backed by
actual oil and so that's kind of how
that market works now someone does
still has to store the actual oil right
because we're doing all of this
financial stuff trading in futures or
ETS but there is someone in the
background actually dealing with the oil
in either storing the oil or selling the
oil to to someone who needs it to
consume and so that oil that you own in
sort of an abstract way through a
financial contract is actually
physically out there in the world
somewhere and so when you're rolling the
future selling will say the cheap May
one right now a very cheap May one
because it's got a negative price and
buying the more expensive June one what
you're actually doing in a way is paying
someone to store that oil for a month
for you right unless think the the term
that we use in in finance for for the
difference in the prices is contango and
as I mentioned I have another video that
I'll link to in the description that
explains contango in greater detail if
you're interested but essentially
rolling the futures the way they are
right now where you're selling cheap
mayil and buying more expensive June oil
the difference in the price is kind of
what you're paying someone to store that
oil for you now of course someone can do
the opposite of that right they could
easily buy the cheap may oil contract
sell the more expensive June one and
then receive the oil when the contract
expires store it for a month and then re
deliver it to whoever needs it and that
would make a profit for them assuming
that they had the ability to store oil
somehow now another way things can work
is if the prices aren't always it's not
always lower for the the near delivery
than the the longer delivery futures
another way it can work is what we call
backwardation and as i mentioned there's
a video on that and that would be where
the price of June oil is above the price
of May oil and what that would then mean
is that the markets are essentially
saying that they will pay you to take a
loyal out of storage because people
really need it
now and so usually in in the oil market
in a lot of energy derivatives you see
what they call normal backwardation but
that's not always the case so right now
what is happening in the oil market well
people do think that oil is valuable
because as I mentioned the June contract
is trading at around $20 and people do
want to bet on its future price but no
one wants it right now and particular no
one wants to own the the contract
expiring tomorrow basically because in
this environment with the whole covert
19 lockdown and no one's really using as
much oil as they normally do and they
don't really have anywhere to store it
so does the May futures contract has
gone negative now what does this desist
is this just a financial thing or does
it tell us something about the real
world
well financial things always tell us
something about the real world and so
what we can see about the real world in
these prices that they're kind of
highlighting a fast-growing glut of oil
in the world that relates to due to a
number of things such as the price of
oil being reduced by Russian Saudi
Arabia but also just the fact that
there's really much lower demand right
now for a while then you typically
expect simply because of the covert 19
lock down and people aren't driving
factories are not all open airplanes
aren't in the air and so on and so less
less energy is being used and in
addition it also highlights growing
stockpile in the United States a lot of
the oil is stored in Oklahoma and those
storages are pretty much full at this
point so what are they calling this well
they're calling this super contango
which is of course like contango but but
it's super and the June contract is way
above the may contract in terms of
prices it's much more contango than you
would normally see and this of course
relates to all sorts of signs
of economic weakness and just weirdness
in the markets that we're seeing during
this this kovat 19 lockdown in in Texas
buyers are offering producers as little
as $2 a barrel for certain streams of
oil it's worth noting that very little
oil actually trades at the price that
you see in the futures market because of
course different oil comes out of
different wells there's different
delivery there's different qualities of
oil and so on so the the price that you
see in the newspaper of oil is kind of
more of a benchmark price but then the
actual oil trades of different prices
based on different deals that been
struck and so on and there is actually
the possibility that producers might
soon have to pay someone to take crude
oil off of their hands now what does
that mean because that's kind of weird
as well and in normal economics you
would think there will be no negative
price we couldn't have a negative price
as simply because if someone is is
offering it if you have oil and someone
is saying you have to pay me to take it
from you you might say well actually
I'll just keep it in the ground oh I'll
just hold on to this oil but the oil
market is a little bit different and a
little bit more complicated than that
and part of it is just tied to this idea
that oil is hard to shut into the ground
like when you've got these wells flowing
you can't just sort of turn a tap and
stop um it's it's more difficult from an
engineering perspective than then
turning off your your kitchen sink for
example and and if you do shut it down
it's difficult to restart an oil well so
all of this stuff is kind of playing
into what's going on in the oil market
in general a global pandemic like what
we're in right now is just weird for all
commodity prices if you have a thing
that lots of people want but nobody
wants it right now like like oil it's
very difficult to put a normal price on
it and that's what we're seeing in a lot
of the world of commodities and even
just in a lot of the world
when we look at stock prices or you know
business investments it's very difficult
to put a price on things right now
simply because it's it's very difficult
for people to to know what's going to
happen going forward so anyhow hopefully
you've found this video a little bit
interesting as I mentioned I have other
videos that are linked to please like
and subscribe if you found this useful
cuz this is the kind of content I make
and do let me know in the comment
section if you'd like more kind of
market update type stuff like this
normally I I don't don't really comment
on today's market but basically I got a
lot of questions and I thought this
would be the easiest way to answer them
so anyhow have a great day guys and talk
to you later bye
