One thing that people like to invest in is oil. You can buy oil to refine into gasoline or whatever, but you can also just buy it as an investment, or a speculation, or a hedge. You buy oil today for $35, if the price of oil goes up to $65 you make money, if it goes down to $15 you lose money, it is a bet like any other.
Or that’s the idea. In fact there is a practical problem with bets like that, which is that oil is voluminous and oozy and poisonous and flammable and smelly. If you want to bet a few thousand dollars of your retirement account on your belief that the price of oil will go up, you will not want to actually fill your garage with barrels of oil to implement that bet. That would be inconvenient.
So instead you turn to financial markets to buy, effectively, abstract oil. You buy a financial instrument that goes up if the price of oil goes up and goes down if the price of oil goes down. That’s what you want, a bet on oil prices without the inconvenience of owning a lake of flammable liquid.
It would be nice if there were just, exactly, that thing. “Permanent abstract oil,” you buy it for the price of oil today and sell it for the price of oil when you want to sell it. But there isn’t, quite. There are oil futures: You buy abstract oil today and it converts into real oil in May, or whenever. You do not want real oil, in May, or ever. Perhaps your bet is just “the price of oil will go up by the end of April.” Then you buy May futures today, sell them by the end of April, collect your profit (or loss) on the bet, and never get any real oil. (The futures you buy and the ones you sell offset; no one delivers you any oil, and you never deliver anyone any oil.)
But more likely your bet is just “the price of oil will go up sometime.” (Just like buying a share of stock is a bet that its price will go up sometime: You are not locked into any time frame.) You do not actually want the May futures, exactly; you just want abstract oil. So what you do is you buy the May futures, to bet on the price of oil without owning actual flammable oil, and then as the expiration date of the May futures gets close you sell those futures and buy the June ones instead. (This is called “rolling” the futures.) As the June expiration approaches, you do it again. You keep owning oil-but-not-quite-yet, giving you exposure to oil prices without the inconvenience of actual oil.
There are legendary stories on Wall Street about newbie commodities traders who forgot to roll their positions and had to scramble to find somewhere to store 10,000 pork bellies or bushels of wheat or barrels of oil or whatever. These stories are funny because they are rare, perhaps mythical; mostly financial traders just remember to keep their commodities trades in the world of financial abstraction.
This is, for instance, what oil exchange-traded funds do. An oil ETF gives its investors permanent exposure to abstract oil, but it generally doesn’t do that by actually owning a giant tank of oil; it does it by buying futures and rolling them. One way to think about this is that someone has to store the oil—the actual oil—that you own abstractly. If oil prices are in contango—if the price of June oil is above the price of May oil—then by rolling the futures (selling the cheap May one and buying the more expensive June one) you are effectively paying someone else to store the oil for a month. Someone else can buy the cheap May contract, sell the expensive June one, take delivery of the oil in May, keep it in their garage for a month and deliver it in June. (If oil prices are in backwardation then someone is paying you to take the oil out of storage because they really need it now.)
Occasionally you will have the odd situation in which (1) people think that oil is valuable and want to bet, abstractly, on its future prices but (2) no one wants any actual oil right now because no one is using it and they have nowhere to put it:
Oil plunged the most on record to below $12 a barrel in New York as a historic demand slump fills inventories to the brim.
Futures fell as much as 40%. While the collapse reflects the most immediate May contract expiring on Tuesday, it nonetheless highlights a fast-growing glut of oil, and rapidly expanding stockpiles at the American hub at Cushing, Oklahoma. OPEC+’s record production cuts from next month are paling in the face of this evaporating demand.
The upcoming May contract’s expiry means traders are shifting their positions to June as they try to avoid taking deliveries of cargoes because of the lack of space to store them. That has opened up an unprecedented discount of more than $10 between the two nearest contracts.
This situation—in which the price of the June contract is far above that of the May one—apparently delights in the name “super contango.” People put a price on oil—they think it has value and want to own it at that value—but they also put a price on not having it now, and the latter price is quite high relative to the former. Conceivably, in theory, the latter price (what you’d pay to not have oil now) could exceed the former (what you’d pay to have oil eventually), leading to negative spot prices. We’re getting there:
There are signs of weakness everywhere. Buyers in Texas are offering as little as $2 a barrel for some oil streams, raising the possibility that producers may soon have to pay to have crude taken off their hands.
In ordinary economics, things do not have negative prices: If nobody wants a thing, if you’d have to pay them to take the thing, you just don’t make it. Oil is a little weird—it is hard to shut in and then restart an oil well, and there are all sorts of weird cartels and game theory involved in oil pricing and production—but the other thing going on here is that a global pandemic is pretty weird for commodity prices. The price of oil is not approaching zero because nobody needs oil; you can look into the future—or at futures prices—and see that, in fact, there is demand for oil. But right now, with the world economy closed, people need much less oil than they’ve got. If you have a thing that lots of people want, but that no one wants right now, it is hard to put a normal price on it.