 Welcome to this quick video to explain what is going on the oil market right now to understand What's happening on the screen in front of you? You need to understand a bit about cantango and backwardation So I'm going to get on to that in just one moment But let me have a look at the live prices now may oil futures You can see this right on the ladder in front of me may oil futures are trading at minus $40 a barrel in effect you can or if this could happen you could buy oil for delivery today At negative $40. I've been trading for nearly 20 years. I've never seen anything like this quite so sharply on this chart I'm actually looking at the relationship between May oil compared to June oil and it's showing minus minus 20 that's not true actually because if may oil is trading at now minus $35 a barrel June oil is trading at $20 a barrel and this is a $50 difference between the price of oil for delivery today compared to the price of oil For delivery in in June. So this is absolutely final. Oh, yeah now that chart has caught up the spreads caught up there That's more like it minus 57 minus 57. There's a $57 spread between May and June oil delivery. I've never seen anything like this So in order for you guys to understand what's going on Let me explain a little bit about some deep theory when it comes to understanding the oil price I'm going to talk about when I last saw something like this in 2011 when we had the Arab Spring, so I'm going to try and keep this short and sharp First of all, this is a quick Bloomberg chart showing well just what I've shown you the front month So the oil price for delivery now being much much cheaper than the oil price for delivery in the future I'm going to come back to that chart at the moment the last time that we saw something like this was in 2011 during the Arab Spring and I remember this really well This is when I don't know if you remember the fruit seller in Tunisia set themselves on fire and protest about the regime and that Spread across northern Africa into Egypt in Tahir Square when Mubarak got deposed by the military And then it moved into the Middle East with Bahrain and Amman and what happened during this time in 2011 there's a lot of US traders took delivery of oil So normally when you trade in the futures market 98 percent of those contracts being traded Don't go to physical delivery, but back in 2011 a lot of the US traders took delivery of oil and cushing became full Cushing is a huge storage facility in Oklahoma where a lot of US oil Get stored the USA has diversified its storage capacity somewhat since 2011 for sure Thanks mainly to the Seaway pipeline, but the cushing element is still a big factor here So when cushing became full what that meant was let's have a look at the spread now minus 33 What that meant was if cushing is full if I was to buy oil in the futures market here If I was to press buy then I've got to take delivery of it But if the only place I can store it is already full then I've got a real problem on my hands because I've got nowhere to put it Now what happened in 2011 just to bring everyone back up to speed was that that meant that the price of US oil Despite everything that was going on in the Middle East with the Arab Spring the price of US oil Actually started to tick lower and that confounded a lot of my colleagues who are trading the spread between Brent That's the oil that derives its price from the North Sea and WTI That's that's US oil a lot of traders will normally trade the relationship between Brent and WTI because they would tend to move together What we started to find in 2011 is the WTI price Started to move lower and the Brent price started to move higher And that's because there was nowhere to store it and that's exactly what we're seeing in the prices today I don't know how many traders out there Remember this and can relate to this scenario, but then absolutely what's happened since the coronavirus outbreak and since the Saudi Russia Power play is that storage capacities have been getting full No one wants to receive oil now. They don't have anywhere to put it Which is why it's absolutely fine to receive it in June. We're trading at $20.39 in June for December oil We're trading all the way at $32 certainly, but for oil now No one's got anywhere to put it to understand why that's the case Let's have a look at the difference between cantango and backwardation I'm going to try and make this as simple as possible So in a normal commodity market where you have to look after a product and store a product You would normally have something called a cost of carry The cost of carry is the price that you have to pay to ask someone to store your commodity for you So let's say if you look at a product like gold if I wanted gold today Then I could buy it today for around $1,700 an ounce. That's great But if I went to an exchange and said to the seller I want that ounce of gold that you've got in front of you, but I don't want it today I want it in 12 months time Then the seller of that gold is going to have to store my gold for me Whilst he's storing my gold for me He's not going to be able to do anything with the money that he could have got for selling it to somebody else So he'll probably charge me what's called a cost of carry And I want you to look at this chart now as like a snapshot like a photo Imagine this point here is now and I'm looking for that gold to be delivered to me in a year's time Well, obviously each month there's a charge There's a cost of carry and therefore the price of gold in the 12 months time If I want to secure that price now is going to be higher than if I want gold delivered today Okay, so that's what we call a normal commodity curve when there's a cost of carry you've got to pay the seller to basically hold that commodity for you and Pay the opportunity cost of not having sold it to somebody else However, oil normally works differently Oil is normally considered a market in finite supply with high demand and rather than having this yellow normal curve We get an inverted curve and it's this inverted curve That means that there's a real belief that there's limited supply And there's a belief that there's high demand and therefore people are willing to pay more to receive oil now than they are if they have to wait and The shape of this curve or the slope of the gradient of this curve is really determined by something called the convenience yield if I find it incredibly Incredibly convenient to have it delivered to me now rather than in 12 months time Then I want to pay a higher price for it now If you're gonna make me wait for five months to receive this commodity that I believe is in high demand and limited supply Then I'm gonna pay a lower price for it so the first thing to understand here in a well supplied market you get a normal curve as You look out into the future the price increases because the price contains the seller's cost of carry Okay, when you have a market with limited supply the curve is Inverted because the buyer is saying even though you've got a cost of carry. I don't care I want this now. It's an in-demand product and I'm willing to pay a higher price for it now So the longer you make me wait the lower. I'm willing to pay for you for the product So that's a snapshot if that's a snapshot then what happens then over time Well over time. This is the expected future price of the product. Okay, that this is a meandering along over time till maturity Normally a product that's in contango. So with a normal curve. Sorry, so at normally normally a normal curve Which is this yellow curve? Okay that Divergence as a result of the cost of carry dissipates over time as we move forward in time So the curve is moving lower and lower and lower and lower until we reach the spot price However, when we have an inverted curve as we often see with oil That futures price moves higher to meet the expected future spot price because obviously as time passes It's less convenient for me to have it earlier because we're getting closer to the expiration of that futures contract So in oil futures contracts expire every month. Okay, normally oil has an inverted curve And is in what we call? Backwardation backwardation means the nearer price is more expensive than the farther price Okay, the farther price is cheaper Which is why over time that farther price has to move higher in order to meet the current spot price that we see Trading physically that the oil that you can actually see and touch So what's happening that strange now is actually all about Convergence and I've had a lot of people ask me about this question. We're now trading at minus twenty five dollars for the May future A lot of people are saying to me. This doesn't make any sense You might as well buy oil now in the futures market get it delivered to you Hold it for a day and then sell it for 20 bucks. You're making $44 a barrel if you do that for a hundred thousand barrels and that's a significant trade that you're looking and it's here it's available now if You had somewhere to put it if you had the capacity to take oil now if you had the margin if you had the funds if you Wanted to take oil now. What's happening now and look we've we were nearly forty dollar minus forty dollars We're back already to minus twenty three What's happening now with this oil futures contract that's about to expire No one wants to touch it, you know, you've seen this bit the liquidity is coming back slightly But you got severe gaps in liquidity Which which means that look everyone's now moved over we've rolled over to June Despite the fact it looks like there's money on the table here now for anyone that wants to buy this May futures contract There's nowhere to put it. There's no appetite to do so and it creates a severe distortion to prices Talking about distortion to prices. I'm going to come back to those conclusions in a moment But I wanted to also then look back to 2008 This is the interesting thing I find about markets patterns repeat themselves here We actually traded a hundred and nearly a hundred and fifty dollars a barrel This is during the financial crisis by the way We started to sell off and this is when we had a forty dollar spike in oil And again, that was all due to do with the calendar rump Molo rollovers Many traders were short they were holding on to their short positions and all at the same time they got squeezed higher pop and Had to had to exit their positions before expire, which normally happens about 9 p.m. UK time So in conclusion, I want you guys to understand the relative for the relationship between the current price versus the future price is normally a Function of supply and demand and that ratio between two calendar months is normally a function of supply and demand Contango and backwardation strategies allow traders to take advantage of Expected convergence and the change in that convergence from the future price to the spot price But what we're seeing now really is quite unprecedented And this is the kind of trend that traders need to be absolutely aware of when if you are Executing an arbitrage trade that means you're trading one product against the price of a related Product and a lot of traders do that for years on end if you are trading that sort of spread or arbitrage trade You absolutely need to be aware when these Correlations break down and you need to recognize this for the type of unique event that we're seeing in front of you in the screen I hope you found that session useful Please do ask us directly if you've got any questions at all info at amplified trading calm. Thanks for your time