The Great Oil Spill Courtesy of USO and China

Shah Gilani May 01, 2020
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Shah here.

Keith started the story last week: he exposed the oil crisis and what was driving it, but the story has developed and as your new editor of Total Wealth, I am thrilled to continue the story.

To those who have been following Keith at Total Wealth for any amount of time: I promise I won’t let you down. I have worked very closely with him for twenty years, and our mottos are very similar. At the end of the day, we know there’s a way to make money – at all times – and we are dedicated to bringing those opportunities to you.

To those of you who have been following me for any amount of time: Thank you for your continued support! I look forward to continuing our journey together, bringing down the Wall Street fat cats and ringing out the stock market for every penny we can.

Starting with the oil crisis.

Want to know why the price of oil last week collapsed to negative $37.63 a barrel? Ask China.

That’s right, China.

The headline stories were all about NYMEX oil futures, based on the April expiring contract which closed on April 21 and required net long holders of expiring contracts to take delivery of the oil they contracted to purchase, not wanting to take delivery because there was no place to store any oil.

So, instead of having to take delivery of oil they couldn’t store anywhere, so the story goes, traders had to sell their futures at any price they could, including down into negative territory.

Selling their open futures contracts down to where the price per contract equaled -$37.63 a barrel meant traders were actually willing to lose $37.63 a barrel (paying someone to take their oil) rather than take delivery of any oil, which, as the story goes, they had nowhere to store.

There’s the story, and then there’s the story behind the story.

The percentage of oil traders who actually take delivery of physical oil, in the case of the NYMEX traded WTI (West Texas Intermediate) contract is more often than not very small. Most traders and hedgers are just either speculating on or hedging price movements in oil. Taking delivery is a big deal, a very big deal.

One NYMEX futures contract represents 1,000 U.S. barrels of oil (42,000 gallons). Any holder of a futures contract after expiration must take delivery of the oil they’ve contracted for, that’s known as physical delivery.

As an aside, Brent oil futures didn’t do what WTI futures did because Brent futures contracts are settled in cash, not by delivery.

If a trader ended up holding 10 WTI futures contracts at expiration they’d be obligated to take delivery of 10,000 barrels of oil. They would have already paid for it at whatever the contract price was they bought the futures for. It’s just a matter of future delivery.

What happened the last day of trading of the April contract (for May delivery of oil) is there were a lot of “long” positions, meaning a lot of traders still owned futures contracts. They didn’t want to take delivery of any oil because that’s not what any of them ever wanted.

But, here’s the thing, here’s the divergence most people don’t understand.

The so-called traders weren’t traders who traded on the NYMEX or at the NYMEX, the traders were mostly retail investors (speculators actually) who bought shares in USO, the U.S. Oil Fund LP (ETF).

They were betting that after Saudi Arabia and Russia agreed to end their price war and take some 10 million barrels a month of oil off the market, the price of oil, which had dropped to close to $18 a barrel, would skyrocket higher.

The real question then should be who were those speculators in USO?

There were plenty of U.S. investors speculating on the price of oil by buying USO. How many we don’t know.

What we do know is there were at least 60,000 Chinese “retail” investors playing the same game.

It hasn’t come out yet, and we may never know, whether contract selling by the USO managers, which had to rollover the April futures contracts they’d bought on behalf of USO shareholders on the last day of trading into May futures (the “rollover”) caused the implosion, or whether other futures sellers who were likewise “long” the contracts up to the last day and had to sell, and they were to blame.

More than likely, it was both. And more than likely it was mostly Chinese retail speculators who got burned.

Chinese mainlanders can’t buy USO, but they can buy Chinese “me too” products. And boy did they ever.

China’s big banks, and smaller ones too for that matter, create “wealth management products” for their depositors and any customers who want to buy them. There’s a whole, very long and sordid story to tell about wealth management products, and I’ll tackle that another time. Suffice it say, several giant banks created Yuan You Bao, or “crude oil treasure” products for their retail customers.

The crude oil treasure products were USO closes. In fact, besides manufacturing their own products banks could have simply invested their customers money in USO, after all, why recreate the wheel?

The giant Bank of China supposedly had 60,000 customers in oil treasure products. Other big Chinese banks had similar products.

While there are no gangs of U.S. investors crying bloody murder, there are tens of thousands of retail Chinese investors smarting from spectacular losses, totaling $1.4 billion, according to Caixin Global, a leading China-centric newspaper.

Caixin’s headline on April 27, 2020 read, “In Depth: A Bitter, $1.4 Billion Lesson on Commodity Price Speculation.” It tells the story of how many retail investors lost so much and are still on the hook for more losses, since the contract they were beneficial owners of traded deeply underwater.

The banks have since said they may not extract the rest of what their customers owe them, meaning, they may pony up the additional losses beyond what the retail product buyers lost, which was everything they had in the products because they had to pay 100% (there’s no margin) for them.

They just didn’t know they could get wiped out and still owe at least as much on account of the futures trading and settling in negative territory.

That’s the real story. As more comes out, I’ll update you, with pleasure.

Until then,


6 replies on “The Great Oil Spill Courtesy of USO and China”

  1. Daniel J Aucutt says:

    What did USO do in response? I heard there was an 8:1 reverse split. I don’t see how that helped them in this crises. I own $4 options expiring Jan 2021, yet USO is now priced in the teens. Does the 8:1 split mean that my $4 options are not in the money until USO trades at $32?

    1. Thomas Thesken says:

      What they did is reduce the contracts by a factor of eight each contract is worth 12 to 12.5 shares Still at the 4.00 exercise price

  2. Mike Dove says:

    Thank you. You and Kieth keep my mind at ease during this trivial time. Can you ask Keith or yourself help me understand how every trading day for the past 6 weeks I’ve notice a sell off of oil Pst sometimes 7am but always each day from 10 to 10:30 before European Markets close and again 11 to 11:30. But since the Friday before last after the big inversion, President Trump was question about how to he can help… those sell off times still happen, but now promptly met with i think DOE or Interior with a buy right away so as stabilize the price again. Finally, Americans need to wake up and be energy independent with independent oil market with no use for the 50 year old OPEC. I stress that our energy producers are the Russian and Saudis FOE. Our great Farmers Of Energy need a subsidy to gap the price to a price that profitable during this crisis for each barrel, say $20 to $40 from government above the current down turn. No tariffs just gap funding… easy. So our great Farmer of Food are supported and subsidize say President Trump. Why not our great hard working American FOEs? We have to fight back independently from our Enemies of Energy get away far away from the OPEC Cartel. They are trying to break us down the FOEs so we again pay them and are dependent. You think the price of gas is cheap now just wait til next summer when its $9 to $10 a gallon because they won the battle and have no more FOE in America! Anyone remember the 70’s and our first lesson of an oil crisis. We need to do better. Lastly, China gets wiser everytime, never under estimate our real Foes. I still remember then real estate bust in the 80’s and all the laugh was we were able to unload all these Golf Courses at the height of the market right before the crash. They own the Riviera and many more fine real estate in America and Banks oh BoA. America keeps selling itself out over the past 50-60 years… God bless President Trump and God Bless this Nation. Humor has it that President Clinton sold all our Water Rights to China. Remember he was so proud of how he balance the budget before he left office. Our Uranium his wife sold off that. How is it that their daughter Chelsea when she was a newly wed, she and her husband had a Canadian Co. Which holds Burger King wholly! Sorry to get off topic. Anyway your thoughts would be much appreciated about the sell offs and the timing i find the markets react precisely at the same time as the oil sells off.

  3. Nick L Unverferth says:

    Will there ever be a correct time to place a bet on price of oil going up?

  4. Doug Getter says:

    Thanks for the insight.

  5. Al breed says:

    Thank you Keith. Welcome aboard Shah.

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