OilOn first principles it is not that surprising that the price of oil would be negative. I mean, look at it. It's a viscous liquid. It smells bad. It is toxic. If you kept it in your garage, you might get sick, or you might get in trouble for storing pollutants improperly, or your garage might explode. If I walked up to you on the street and tried to give you a barrel of oil, you would naturally charge me for taking it off my hands. It is an all-around unpleasant substance. But you can refine it into products that produce energy. So humanity got over the problems with oil long ago and, despite its unpleasantness, it has spent a century as the literal fuel of the world economy. It is gross bad stuff but we need it to drive cars and fly planes and move cargo and otherwise do all the things we like to do. Now we are not doing those things. The world economy is closed. Oil's use value has collapsed. You are left with a viscous smelly toxic polluting inflammable useless ooze. Not entirely useless, I mean—cargos and delivery trucks are still moving—but everything happens at the margin, and on Monday the "unpleasant ooze" factor significantly outweighed the "useful for powering the economy" one: April 20, 2020 will go down in oil-market history as the day when the U.S. benchmark price for crude dropped below zero for the first time -- and then kept falling. In a massive and unprecedented swing, the future contracts for May delivery of West Texas Intermediate tumbled to minus $37.63 a barrel. The jaw-dropping development was in no small measure down to an extreme glitch in the way oil futures operate. But it also revealed a fundamental truth about the oil market in the age of coronavirus and the aftermath of a price war: The world's most important commodity is quickly losing all value as chronic oversupply overwhelms the world's crude tanks, pipelines and supertankers. … The lowest prices came in trades in futures -- contracts in which a buyer locks in a purchase at a stated price at a stated time. Futures are a tool for users of oil to hedge against price swings, but also a means of speculation. The contracts run for a set period, and traders who don't want to unwind their position or take delivery generally roll over their monthly contracts shortly before expiration to a month further in the future. Contracts for May delivery were due to expire on April 21, putting maximum pressure the day before on traders whose contracts were coming due. For them, selling at a steeply negative price was better than taking delivery of actual oil because nobody needs it and there are fewer and fewer places to put it.
As we discussed on Monday, this is not quite a story of "the price of oil is negative"; it is more a story of "the price of physically settled front-month West Texas Intermediate oil futures is negative." If you buy oil futures you might be a refiner or physical commodities trader planning, at the expiry of the futures contract, to take delivery of thousands of barrels of oil. But you might not be. You might just as well be a financial trader—a bank or a hedge fund or an oil exchange-traded fund—planning only to bet on the price of oil; when the May contract expired, you intended to sell it (and possibly buy the next, June contract to roll your bet). As the May expiry rolled around, all the financial buyers wanted out, but none of the refiners wanted any more oil—because, again, the world economy has stopped—and so the financial traders had to pay someone quite a bit of money to take the oil off their hands. Events in the real world caused this—the real actual lack of current demand for oil was the basic problem—but oddities of financial markets exacerbated it; what made the price negative thirty-seven dollars was less "drillers have produced too much oil and are rushing to get rid of it" and more "financial speculators have purchased too much virtual oil and are rushing not to actually get it." Bloomberg News reported Monday: The price on the futures contract for West Texas crude that is due to expire Tuesday fell into negative territory -- minus $37.63 a barrel. The reason: with the pandemic bringing the economy to a standstill, there is so much unused oil sloshing around that American energy companies have run out of room to store it. And if there's no place to put the oil, no one wants a crude contract that is about to come due. Underscoring just how acute the concern is over the lack of immediate storage space, the price on the futures contract due a month later settled at $20.43 per barrel. That gap between the two contracts is by far the biggest ever. "The May crude oil contract is going out not with a whimper, but a primal scream," said Daniel Yergin, a Pulitzer Prize-winning oil historian and vice chairman of IHS Markit Ltd.
Here I want to talk a bit more about the financial weirdness. Again, it is not that weird, on first principles, for the price of oil to be negative: It's a gross ooze that is costly to store or dispose of, and no one is using it right now. It is also not that weird, mechanically, for the futures price to be negative. It mean it is unprecedented, and it is weird financially; you'd expect an efficient market to figure out the storage problems more than one day ahead of expiry, and unwind contracts in a more orderly way. But mechanically the negative futures price is mostly straightforward and intuitive. Futures trade on an exchange, there is a clearinghouse, everyone has to be creditworthy and post daily margin both ways as the price moves. If the price goes down, money moves along well-understood channels from the long party to the short party; if the price goes down to negative $37.63, those channels keep working. What is weird, mechanically, is that people have built financial products—often retail financial products—on top of oil futures, and those products implicitly assume that the lowest possible price for oil futures is zero. Basically you put oil futures in a box, you sell the box to investors, if oil prices go up the investors make money, if prices go down the investors lose money, if prices go to zero the investors lose all their money. Normal stuff. But if prices go to negative $37.63, you are not prepared for that. Futures exchanges have all the good two-way margin posting to make it work fine, but your retail product doesn't, and you are in trouble. The simplest retail product is just "being a broker and letting your retail customers trade futures." Here's an Interactive Brokers press release from yesterday: Interactive Brokers Group, Inc. (Nasdaq: IBKR) today noted that, as has been widely reported, the energy markets yesterday exhibited extraordinary price activity in the New York Mercantile Exchange (NYMEX) West Texas Intermediate Crude Oil contract. The price of the May 2020 contract dropped to an unprecedented negative price of $37.63. This price was the basis for determining the settlement price for cash-settled contracts traded on the CME Globex and also on a separate, expiring cash-settled futures contract listed on the Intercontinental Exchange Europe ("ICE Europe"). Several Interactive Brokers LLC ("IBLLC") customers held long positions in these CME and ICE Europe contracts, and as a result they incurred losses in excess of the equity in their accounts. IBLLC has fulfilled the firm's required variation margin settlements with the respective clearinghouses on behalf of its customers. As a result, the Company has recognized an aggregate provisionary loss of approximately $88 million.
In general futures trading is done on margin; if an Interactive Brokers customer bought 1,000 barrels of oil for $50 each—the price of the WTI May contract in late February—she probably didn't put up $50,000 of her own cash. But even if she had, her actual losses on the contract were $87,630 (negative 175%), not $50,000, and she certainly didn't put up $87,630 to buy a $50,000 contract. And if she can't cover the losses, her broker has to. Another popular retail product is the oil exchange-traded fund. An oil ETF is just a box that buys oil futures (and rolls them each month), and that sells shares in the box to investors. A notable one is USO, the United States Oil Fund, "a perennial money-loser that still somehow controls a whopping 30% of the June benchmark U.S. crude futures contract." The problem is that oil futures prices can go negative, but ETF share prices really can't. If you buy a share of stock—including ETF stock—on a stock exchange, and its value goes to zero, you can walk away; no one can ask you for more money. USO's value hasn't gone negative—it avoided Monday's negative prices—but the structure has become a worry: USO already had rolled its positions out of the May contract days ago, but the June contract represents a lot more oil and when it expires there will be even less storage left at the delivery point of Cushing, Okla. It is unclear how exchange operators CME Group or Intercontinental Exchange will react if June futures, which plunged by as much as 37% on Tuesday morning, also go negative. Passive holders of an ETF can't be asked for collateral. The fund could be liquidated to forestall such a scenario, but that would, in and of itself, roil the futures market. Neither CME nor ICE responded immediately to requests for comment. The good news for retail speculators is that they can't lose more than 100% of their money, unless they bought futures directly. Incredibly, despite a sharp drop in its price, USO was trading at a big premium to net asset value Tuesday morning as the fund's operator, USCF—motto "Invest in What's Real"—stopped allowing new shares to be created.
USO is a pot full of investors' money, which it puts into oil futures. In general that is a safe structure: The worst that can happen is that it loses 100% of its investors' money. But if it loses 175% of its investors' money, that's a problem, because it just has what is in the pot; it doesn't have any more money. This is not a problem that one would normally anticipate in trading oil futures, since they have never gone below zero before and there seemed to be good reason to assume they never could. Now they have. USO has responded to this worry by changing its investing rules: United States Oil Fund, LP ("USO"), a Delaware limited partnership, announced previously in a Form 8-K filed on April 17, 2020 that commencing on April 17, 2020 and until further notice and market conditions and regulatory conditions permit otherwise, USO would invest approximately 80% of its portfolio in crude oil futures contracts on the NYMEX and ICE Futures in the front month contract and approximately 20% of its portfolio in crude oil futures contracts on the NYMEX and ICE Futures in the second month contract, except when the front month contract is within two weeks of expiration, in which case the futures contracts held by USO will be rolled into the second month contract and third month contract. Commencing on April 21, 2020, because of extraordinary market conditions in the crude oil markets, including super contango, USO has invested in other permitted investments, as described below and in its prospectus. In particular, on April 21, 2020, USO invested in approximately 40% of its portfolio in crude oil futures contracts on the NYMEX and ICE Futures in the June contract, approximately 55% of its portfolio in crude oil futures contracts on the NYMEX and ICE Futures in the July contract and approximately 5% of its portfolio in crude oil futures contracts on the NYMEX and ICE Futures in the August contract, except when the front month contract is within two weeks of expiration, in which case the futures contracts held by USO will be rolled into the July contract, August contract and September contract. In addition, commencing on April 22, 2020, USO in response to ongoing extraordinary market conditions in the crude oil markets, including super contango, may invest in the above described crude oil futures contracts on the NYMEX and ICE Futures in any month available or in varying percentages or invest in any other of the permitted investments described below and in its prospectus, without further disclosure.
Basically it has gone from "we will own the front-month futures and roll them on a regular schedule," which is a problem if everyone else is rolling on the same schedule and prices go negative, to "we will buy some oily stuff but we might not tell you what it is." Which is fine! The right approach, really; if you are 30% of the futures market and predictable, people are going to anticipate your moves and bet the other way, and that is especially bad now. It is not a complete guarantee against going negative, though, and it is not exactly what you want in a retail exchange-traded product: The U.S. Oil Fund's operator, United States Commodity Funds LLC, said it has issued all registered shares and suspended the ability of purchasers to buy new creation baskets. Such baskets hold the fund's oil futures. The move will essentially make the ETF a closed-end fund with a fixed number of shares for now. That could make it even more volatile, because its price can now diverge from the fund's total asset value.
Here's an investor, by the way: "I'm either going to get my ass handed to me or I'm going to be really smart," Sean Douglas, a 36-year-old entrepreneur in Raleigh, N.C., said. "I'm going to just ride it all the way." He invested about $1,000 in the ETF this month. Its price fell 25% to $2.81 on Tuesday, bringing its drop in the past week to 41%.
Meanwhile in the world of physical reality, if the price of oil is negative eventually people are going to stop making oil: "Demand is contracting two or three times as fast as supply," said Bob McNally, president of consulting firm Rapidan Energy. The drop in prices is a "brutal but efficient" mechanism to "persuade producers to keep oil under the crust," Mr. McNally said.
And: A historic crash in crude prices is driving U.S. shale into full-on retreat with operators halting new drilling and shutting in old wells, moves that could cut output by 20% for the world's biggest producer of oil and leave thousands of workers unemployed. For shale companies, the price of West Texas Intermediate crude went from hunker-down-and-ride-it-out mode to crisis mode in just a few days, with many now unsure whether there will even be a market for their oil. Some 1.75 million barrels a day is at immediate risk of shutting down while the number of new wells being brought online is forecast to plunge almost 90% by the end of the year, according to IHS Markit Ltd.
Imagine running one of the more than 10% of new shale wells that are still being brought online. Imagine your sense of urgency. "Gotta get this well running smoothly so it can produce oil so we can pay someone to take it." Think how much more profitable your company would be every day you stayed home to play video games instead of finishing that well. Elsewhere in oil: - "Oil tankers carrying enough crude to satisfy 20% of the world's daily consumption are gathered off California's coast with nowhere to go as fuel demand collapses."
- "At least one in 10 supertankers around the world is serving as a floating oil storage facility, Saudi oil officials say."
- John Kemp criticizes the structure of West Texas Intermediate oil futures, which have done so much worse than other crude futures. "Unlike Brent futures," he writes, "which are settled financially based on an index of seaborne crudes with good access to international markets, U.S. futures are settled physically at an inland location, limiting their flexibility."
- " Why Oil at Negative $100 Isn't a Crazy Bet Anymore."
PPPThe U.S. government is distributing free money to small businesses so that they can stay afloat, and keep paying workers, during the coronavirus shutdown. It is doing this through the Paycheck Protection Program, in which banks lend the money to small businesses, and then the government (the U.S. Small Business Administration) pays back the loans if the businesses use the money for payroll. This is, broadly speaking, sensible. I once wrote about it: It is a public-private partnership that plays to each side's strengths. Banks are, precisely, in the business of vetting applications from local restaurants, examining their financial records and deciding how much money they need. The government, meanwhile, is best equipped to generate magical quantities of money. The banks do something recognizably bank-like—market and underwrite small-business loans—and the government transforms them into magical free money.
That's the idea. But if you are enlisting banks to run your program, you are going to get … banks. Like, the banks are going to behave in recognizably bank-like ways while they are doing the bank-like job of handing out the loans. Some of that will be good: You want the banks to check that the small businesses exist and aren't stealing the money and so forth. Some of it will be good-ish, or debatable: You want the banks to check that the documents are all in order and that the loans match the businesses' actual financial needs, but you don't want them to spend so much time checking that the businesses never get their money. And some of it will be … not exactly bad, necessarily, but at least unrelated to the goals of the program. The basic goal of the PPP is to give money to small businesses. You might refine that description a bit: "to give money to small businesses that need it to keep employees," or "to give money to small businesses that are likely to be viable after the shutdown ends," or whatever. But you would not, from the perspective of the government or taxpayers or society, say that the goal of PPP is to give money to banks' best customers. Generating a lot of revenue for banks, doing a lot of financial transactions, having a good personal relationship with bankers: None of these things are particularly important to the social goal of distributing government money to small businesses. But if you hire the banks to distribute the money, those things are important to the banks, and they are going to have a tendency to favor their good customers. So: JPMorgan Chase & Co. provided loans to virtually all of its commercial banking customers that sought financing through the small business relief program, while the lender's smallest customers were almost entirely shut out, according to data disclosed by the bank. More than 300,000 customers of JPMorgan's business banking unit, which serves smaller firms, applied for loans through the Paycheck Protection Program, part of the $2 trillion Cares Act that Congress adopted in late March. About 18,000 were funded, for a 6% success rate. By comparison, about 5,500 larger, and sometimes more sophisticated, customers of the commercial banking business applied for funding. Nearly all of them got loans, according to the bank's data. JPMorgan made a total of $14 billion in small-business loans through the program. The data reveal that, in the race to get a loan in the first-come, first-served program, larger businesses had a leg up over smaller ones -- even when applying through the same bank.
And: Wells Fargo & Co., Bank of America Corp., JPMorgan Chase & Co. and US Bancorp were sued by small businesses that accused the lenders of prioritizing large loans distributed as part of the virus rescue package, shutting out the smallest firms that sought money. The four banks processed applications for the largest loan amounts because they generated the highest fees, rather than processing them on a first-come-first-served basis as the government promised, according to lawsuits filed Sunday in federal court in Los Angeles.
I mean the banks dispute this a little, but really, what else would you expect? If you are a big—but nonetheless technically "small business"—customer who has a good relationship with your banker, you are going to call her up and ask her to get you some PPP money, and she is going to try, and if she is a big banker who has good relationships with lots of profitable clients, she is going to get it done. If you are a local restaurant who has never met a banker but who has a checking account at a giant bank, you are going to be placed on hold, and that is the end of your story. If you intermediate a government program through private businesses, business considerations are going to creep in. And because PPP ran out of money—the Senate just voted for another tranche, though it's still not clear that every business that needs PPP money will get it—there is controversy about who got it. The controversy is largely of the form "hey these big and relatively less needy companies got money when smaller and needier companies didn't." So for instance venture-backed companies applied for money: Many startups rushed to claim funds from the U.S. government's small business loan program. Now venture capitalists and startup founders are debating whether they should have. Some object to companies with potentially millions of dollars in cash or access to rich investors applying for rescue funding from the federal government's Paycheck Protection Program, pointing to closed restaurants, hair salons and bars that need the money more. Others, however, argue that many startups genuinely need the money because their businesses were hit hard too and investors have stopped writing checks.
Hedge funds: Institutional investors in Pennsylvania and Alaska are taking a dim view of hedge funds and other asset managers seeking to tap emergency U.S. government money designed for struggling small businesses. Pennsylvania's Public School Employees' Retirement System is monitoring its managers -- as well as potential new ones -- to see if they took advantage of the rescue program. The Alaska Permanent Fund Corp. said it would view any manager taking assistance "quite negatively." Some funds have already applied, Bloomberg earlier reported.
Public companies: Dozens of publicly traded companies received forgivable loans totaling more than $340 million from the Small Business Administration's Paycheck Protection Program, according to a Wall Street Journal analysis. Shake Shack Inc. was the biggest recipient by market capitalization, while Ruth's Hospitality Group Inc. got the most funds at $20 million—by applying for the maximum amount through two subsidiaries. Eighteen of the 88 companies employed more than 500 people. Twenty-six reported more than $100 million in annual revenue in their last fiscal year.
Restaurant chains: No one wants to take the blame for the loophole that allowed name-brand restaurant chains like Shake Shack to get huge sums of pandemic-relief money meant for small businesses. Lobbyists, lawmakers and agency officials deny responsibility. Yet fingers are pointing over how big national chains including Potbelly Corp. and Ruth's Chris Steak House landed $10 million or more apiece in loans while millions of mom-and-pop firms were left stranded when the program ran out of money.
Again, this is just what you'd expect. Public companies, hedge funds and venture capital firms all tend to consume more banking services, know more bankers and be more lucrative for banks than hair salons and bars. Restaurant chains are better banked than mom-and-pop restaurants. I must say it does not strike me as especially nefarious that eligible-but-not-hugely-sympathetic businesses would apply for PPP loans: If the government wants to give them money to keep workers employed, why shouldn't they take it? Nor does it strike me as particularly nefarious that banks would have set up systems to do more business with their bigger customers, or that those systems would continue functioning even in the current crisis. Businesses and banks are just doing what makes sense for them, and there's no rule that they can't, or even any great reason why they shouldn't. The problem is mostly that the government has (1) allocated less money than is needed, and (2) deputized banks to prioritize who gets it. Of course the banks are going to act like banks. 24/7 futuresI have written a few times that it might be nice if, instead of trading for 6.5 hours a day, U.S. stocks traded for, say, half an hour a day. Everyone could think about stuff for the other 23.5 hours, obtaining and synthesizing information and formulating views about what that information means for stock prices, and then they could all get together for half an hour to exchange views and do the actual trading. In a sense this is happening naturally already; a lot of trading volume on U.S. exchanges happens in the half-hour leading up to the close, and a lot of price action happens in the opening few minutes, rather than being spread evenly throughout the day. People want to trade when everyone else wants to trade—liquidity is better if everyone is trading all at once—so they naturally gravitate toward a few short, intense, liquid periods. On the other hand there is also a countervailing natural tendency, which is that if you acquire and synthesize some information at 2 p.m., or 2 a.m., or whenever, you get antsy to trade right now rather than waiting for the liquid periods when everyone else wants to trade. And you can, and people increasingly do: Trading in overnight stock futures has skyrocketed, adding to a nearly nonstop stretch of market activity and luring more investors to join in the action. Among the most-traded are E-mini S&P 500 futures contracts, whose overnight trading volumes have surged to a record this year, according to CME Group Inc. data through March. Daily average volumes have topped 500,000 contracts, more than double the number recorded in 2017. The overnight session begins at 6 p.m. ET on Sundays and weeknights and ends the following day at 9 a.m. ... The explosive moves overnight—and record activity—come as investors around the world are trying to parse the ramifications of the coronavirus pandemic on the economy, hungry for information to help them understand the extent of its spread. Outside of regular stock-trading hours—9:30 a.m. to 4 p.m.—news from the White House and Federal Reserve alongside updates on the pandemic often draw swift moves in the futures market. For example, the central bank's decision to slash interest rates to near zero in response to the coronavirus took place on a Sunday in March, spurring selling in the stock futures market.
Both of these trends make economic sense—people want to trade when everyone else trades, but they also want to be able to trade before everyone else trades—but the trading-half-an-hour-a-day trend strikes me as sort of soothing and humane, while the trading-24-hours-a-day trend just seems exhausting. Blockchain blockchain blockchainI spent like a month wondering when this headline would appear, and it turns out the answer was last week. I give you: "Using Blockchain and DLT to Fight the Spread of COVID-19." "Using Blockchain and DLT to Fight the Spread of COVID-19"! "Using Blockchain and DLT to Fight the Spread of COVID-19"! Terrific stuff. Things happenStress Endures in Market Where Big Companies Turn for Cash. Credit Funds Lure Big Investors Betting on a 2009-Style Rebound. "What we have here is an unprecedented nationwide force-majeure event." French markets regulator fines hedge fund Elliott €20m. SEC Proposes to Modernize Framework for Fund Valuation Practices. Facebook buys $5.7bn stake in India's Reliance Jio. How Hong Kong's Intervention Battle Will Chill The Carry Trade. 'Scary Time' for American Middle Class as Office Jobs Disappear. Why You Miss Those Casual Friends So Much. If You're Going to Grow a Quarantine Mustache, Listen Up. Name of the Year. If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks! | 
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