Supply and Demand Gets a Rethink! – Guest Post
What’s this trading thing all about? What makes it go?”, are common questions you might get from your “non-financial” friends and family.
If you are smart and want to keep it simple, your answer might sound something like, “Supply and Demand. It’s all about Supply and Demand; everything from toothpaste to your house, to currencies, or anything for that matter. If people want it, the price goes up. If they don’t want it, the price goes down.”
“OK. I see!”, they might respond, and the more savvy ones might dig deeper and ask, “So, when the Central Bank lowers interest rates, why does the value of a currency go down?”
You answer, “Again; Supply and Demand. When interest rates go down…less desirable…value falls. Supply and Demand.”
That’s the quick answer of course and, depending on the audience, you can go much deeper and make it far more fascinating (or more boring, depending on your victim). However, when responding to that question, I can absolutely, positively guarantee that you would never come up with, “The value of the dollar goes down because there is no place to put it! We are just bursting at the seams with all the dollars!”
That just doesn’t happen.
However, looking at Crude, with the current state of our global “locked-down” economies, nobody is flying, driving, waterskiing, or manufacturing much. Therefore, demand is so low, and the market is in such a state, that the major financial news networks felt it necessary to introduce us to a small town in the US called Cushing.
Cushing, Oklahoma is where all the WTI goes while it waits for someone to export it or send it to the refinery and, until recently, the town had diminishing importance. Now, it’s like that expensive club that you can’t get into and no amount of credit cards, or bribing the doorman, will get you a seat at the table.
Not bad for a town of 7,800 inhabitants, storage for 76 million barrels of oil, a Pizza Hut, and a huge Wal-Mart. Basically, industry experts are predicting that supply will exceed storage capacity at Cushing within a few weeks.
So, our “Supply and Demand” philosophy takes on a whole new paradigm: “Supply, Demand, and Where-the-heck-do-I-put-it?”.
In fact, the “supply/demand/where-the-heck-do-I-put-it?” ratios became so skewed, that the May WTI contract went seriously negative with producers “waving the white flag” saying, “Help! I don’t want this and I will pay you to take it away.”
Brent Crude has a completely different set of storage issues as the cost of supertankers keeps rising by the week and, of course, they have no place to go. Ironically, it seems that the biggest consumers of oil now are the supertankers putt-putting around the oceans wondering who will want all this Brent Crude.
This is not the first time that this has happened and, in fact, we have seen this movie recently. Last year, more than once, the price of Natural Gas (often a by-product of Crude Oil drilling) went negative for the same reasons.
So, a couple of weeks ago, just after WTI dipped below -$40 per barrel, I did a video explaining the difference between the spot price of US Oil and the various flavours of futures contracts. Inevitably, the question came back from a retail trader, “Should we buy Crude Oil then?”
The simple answer is, “Yes”. However, very often simple answers create complicated questions. In this case, the “Yes” must be followed by a “When?”
Many analysts feel that we are not out of the woods yet. We see most economies talking about lifting social distancing restrictions, which means that we can drive our cars to the petrol station, but we aren’t likely to be heading to the airport anytime soon. Manufacturing may begin but it will probably limp back to life as companies will have to ease the workforce back, slowly and safely, and perhaps with limited production.
The point being, it will take months to clear the backlog of crude inventory and we still have the threat of negative crude in a couple of weeks when the June contract expires. Having said that, S&P Global – the largest commodity index – has rolled its June contracts into July to protect investors, but this seems like climbing a tree to get away from the wolf. Eventually, you have to climb down out of the tree.
Now, if life and trading weren’t interesting enough, we will have to combine the “supply/demand/where-the-heck-do-I-put-it?” ratios with our old friend – “Trade War”. (Remember last year when every tweet or press conference on US/China would screw up your open positions?). Well, news from the Orange Office indicates that US/China relations may be on the rocks again, even before we emerge from this COVID-19 thing. So, if you missed the market fluctuations from “Tariffs-R-Us” last year, the sequel of that movie is about to hit the cinemas, just when you didn’t want to buy the popcorn.
There is, in fact, a cinema in Cushing, Oklahoma. Sadly, it looks like it will be closed for a while.
This guest post comes as a courtesy of from Brad Alexander, the founder of FXLarge, a leading content creation company for brokers and investment firms. In this post, Brad has shared his thoughts on the recent Crude Oil calamity and the supply and demand principles.