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How to Invest in Oil and How NOT to Invest in Oil

Knowing how to invest in oil means not having barrel of it leaking around your home. | By fernost (Self-photographed) [Public domain], via Wikimedia Commons

With crude oil prices having gone negative, everyone and his sister is scrambling to figure out how to invest in oil and make bank where banks have failed: There must be a way to get someone to pay me to take oil off their hands so I can resell it when the world is normal again and make a killing, right?

This week’s story of crude carnage offers oil investment lessons from a small-time trader to the massive central bank of China. The little guy almost got washed out, but with a shot of luck made a narrow killing in the end — a bit too narrow for most, including him. At that same moment, the Goliath Bank of China, took a stunning hit between the eyes.

Trying To Make Money Off Oil, This Guy Almost Wound Up With A Basement Full

In fact, he almost wound up with every basement in his home town full of oil:

I bought a few contracts of WTI CL 05-20 Futures yesterday at the low tick of -$32. Started taking profits off as it rose, but let one single contract run to $-4.

It seemed easy to invest in oil when people are paying you to take it! That was until he realized that, when the contract closed at the end of the day, he’d have to take possession of the oil! Things could have gotten messy at that point because, while oil is measured in barrels, it doesn’t usually come wrapped in them.

Investing in oil futures contracts for West Texas Intermediate isn’t like buying bonds. You’re actually buying a commodity that you have to take physical delivery of in Cushing, Oklahoma.

“What’s that? You have a train pulling up to dump oil at the end of May? Not sure my swimming pool and basement will hold that much.”

Then there are those EPA spillage fees involved with improper storage. There are a lot of ways this deal could have gone more sour than the worst of crude.

update: Thankfully the CME/NYMEX has procedures for situations like this. Final contract settlement is done by cash settlement (minus a small settlement fee) for those not wanting to take physical delivery. NYMEX rulebook section 698103….

Edit 2: yeah that rule book I referenced ? That’s for a different product. Rip.

Fortunately, when the market became a lot less liquid than oil this week, this guy figured out how to invest in oil futures and actually made about $26,000. It was simple: he prayed for angels of mercy, and they delivered, and when he returned from his heart replacement surgery, he kindly put himself up as an example of what not to do:

Praise be to the Autism gods, I was able to exit my trade due to someone else entering the market and buying my contract…. Thank you all that have reached out offering your help to store this product. Best comment goes to … “love it when our austim [sic.] bleeds into the physical realm like this.”

He almost bled black.

Many investors experienced the impossible this week when storage in Cushing reached tank tops so oil had nowhere to flow, causing negative crude oil prices. Even people in ETFs, who never once thought about oil being a physical reality that must be dealt with because they were only trading paper (they thought), learned they had better think about reality.

Here’s a clear explanation of how this whole crazy contango went down and what to be careful of if you invest in oil so you don’t lose money like those who went long for too long:

Bank Of China Knows How To Invest In Oil And Still Got Tarred

China’s central bank was trying to roll over their oil futures contracts for May delivery in WTI, as they are accustomed to doing at this time of month. They play to make the big money by waiting to the last minute. Only this time, they found no one on the other side of the trade, and their angels weren’t so merciful. Smelling blood, those who did have storage outside of Oklahoma, waited until the BOC coughed up enough to make it worth rerouting the oil to the West Coast.

Bank Of China Sold Oil’s May Contract Into A Historic Implosion In Crude — And Retail Investors May Have Gotten Crushed

Chinese banks hawked wealth-management products tracking U.S. oil futures, marketed with flashy names like “crude oil treasure” to ordinary Chinese looking to find ways to invest their cash.

Banks and investors got slammed when banks offering these products found themselves in the unheard of position of having no one who would pay for oil because of the corona crush at Cushing. The had a lot of the current contracts to sell in order to roll into next month’s futures … or fill the banks’ vaults up with barrels of oil.

Bank of China … was rolling over West Texas Intermediate U.S. futures for May delivery on Monday, only a day before they were set to expire, unlike other Chinese banks who rolled over their oil futures at earlier dates, reported Caixin, citing traders familiar with the matter.

Oops.

Bank of China sold the May contract into a maelstrom of selling, with the now-defunct contract eventually settling at negative-$37.63 a barrel on Monday…. Angry retail investors reported they had lost all their principal, while some even said they now owed money to Bank of China.

For some perspective on how unusual this was, here’s the price of oil throughout modern history:

Think twice about how to make money on oil with this kind of price action
You can invest in oil and make big or lose even bigger. | Source: MarketWatch / Deutsche Bank

A barrel of WTI crude is effectively cheaper now than it was before cars were invented. In fact, an empty barrel of WTI became worth a lot more than a full one.

Big US Oil Funds Go for Broke

Before you decide to invest in oil to make more bank than the bank, consider the United States Oil Fund (USO), down 80% YTD.

Every day is now a scramble for survival for the largest oil ETF, the USO, which is desperate to avoid the liquidation that its smaller peer, the OIL ETN … succumbed to yesterday…. To survive, it will succumb to the lowest tricks in the book … puffing up its stock price using such cheap gimmicks as reverse stock splits…. As a result of the reverse share split, USO shareholders … will receive one post-split share of USO for every eight pre-split shares of USO they hold.

Maybe the sudden rise in share values will trick the dumbest retail investors into thinking they just made money with their oil investment, even though they have one-eighth the number of shares they once held.

Right now, that’s how you make money in oil. You didn’t know fools gold came in black, did you?

(This article was originally published on CCN)

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