Something historic happened with the May contract for oil
Bearish Factors
This steep difference between front-month and later-month contracts has been present for most of the year which creates contango. Under contango, investors can buy oil, take delivery, store it, and sell a later-month contract for a guaranteed profit. Due to the popularity of this trade, there's a shortage of places to store oil which exacerbated the downward spiral in the May contract.
Another reason for the extreme move in the front-month contract is thin volume as most investors were focused on the June contract with the May contract nearing expiration. The weakness in oil also highlights a growing divergence between the stock market and the real economy. In the short-term, the stock market is driven by emotions and people's perceptions about the future.
Longer-Term Considerations
While in the longer-term, the direction and trajectory of equities are determined by earnings and economic growth. Commodities are driven more by supply and demand especially as they near expiration. This is yet another sign that the real economy is not mirroring the stock markets' optimism about the future.
Another consideration is that many energy companies have huge amounts of debt. Due to their low credit ratings, they may not qualify under the Fed's credit facilities. Thus they face the threat of bankruptcy especially if oil prices stay low and cannot meet their obligations. Given current prices, many are not profitable and are battling the clock as they fight for survival.
The weakness in oil persists despite promises of big cuts between OPEC+ and the U.S. which amounted to nearly 10% of daily production. Less supply is helpful but it's meaningless in a world where air travel has dropped by 90%, and other sources of demand like driving and industrial activity are steeply lower as well.
Lessons From the Last Boom and Bust
There are some lessons from the previous boom and bust in oil. Oil prices were persistently low from the early 90s to 2002. It resulted in a lack of investment, exploration, and production. When demand surged in the early 00s, oil climbed all the way to $150 in March 2008. During the Great Recession, demand dropped, and oil fell to under $30 before trading between $80 and $100 between 2011 and 2014. In 2016, oil also dropped under $40, but it wasn't persistent enough to result in meaningful supply cuts.
High oil prices led to huge amounts of investment in exploration and production. It also led to innovations in shale production which contributed to the US once again becoming a major oil producer. These investments resulted in massive amounts of supply and today's low prices which are being exacerbated by the drop in demand.
