Introduction
In 2020, the world watched an extraordinary event unfold in the oil markets — oil prices briefly went negative. On April 20, 2020, U.S. oil prices collapsed in historic fashion: the May futures contract for West Texas Intermediate (WTI) plunged from $18 a barrel to around -$37 in just a few hours. The next day, Brent crude fell to about $9.12 a barrel, a steep drop from over $70 at the start of the year.
It was a moment that left even seasoned investors scratching their heads. The reason wasn’t that oil lost its value overnight; it was because there was nowhere left to store it. This strange situation highlighted a key piece of the oil market puzzle: the crude oil storage trade.
Understanding the importance of crude oil and how it works can help anyone curious about crude oil investment see how physical logistics influence financial gains.
What Is the Crude Oil Storage Trade?
The crude oil storage trade is a strategy where traders and energy companies buy oil when prices are low, store it, and sell it later when prices are higher. The goal is to profit from the difference between the spot price (current low price), store it in tanks, terminals, or even ships, and lock in a future sale at a higher price using futures contracts.
This trade works best when the market is in a state of “contango.” That is, when future prices are higher than current ones. Traders just wait for those higher prices to materialize. The crude oil storage trade becomes especially important in times of oversupply, like during the 2020 oil crash. It’s because the storage space itself became so scarce and valuable that prices briefly turned negative.
Key Concepts of the Crude Oil Storage Trade
Spot vs. Futures Prices
A spot price reflects the current market value of the oil. It’s the price you’d pay today for immediate purchase and delivery. The future price, on the other hand, represents the agreed-upon cost for a transaction that will occur later. It factors in what’s known as the “cost of carry” (the expenses tied to storing, insuring, and financing the commodity until the future date.
While spot prices show what a commodity is worth right now, future prices build on that number by including storage costs and interest over time. However, future prices aren’t always higher. They fluctuate with market expectations around supply, demand, and production. Together, spot and future prices reveal both the oil’s present value and how the market anticipates its future.
Contango and Backwardation Defined
-
Contango: Futures prices are higher than spot prices. Hence, traders are known to invest in oil at current low spot prices. This makes storing with an understanding of the importance of crude oil potentially profitable. Contago is an indicator of rising demand or limited short-term consumption
-
Backwardation: When futures prices are lower than spot prices, it signals that storing oil could lead to losses. Hence, it’s reflecting market expectations of supply constraints easing and a decline in future demand.
Storage Costs and Logistics
Storage isn’t free of cost and involves both net profits and losses. Traders must consider tank rentals, transportation, and insurance under logistics when dealing with oil storage. If these costs outweigh the potential profit from selling oil later, the trade doesn’t work. The success of oil trading, therefore, depends on maintaining a balance between physical costs alongside market analytics and trend alerts in prices.
Learning from the 2020 Negative Oil Price Crash
When the COVID-19 pandemic hit, global travel stopped and factories slowed down. The world suddenly needed far less oil, but oil wells couldn’t simply shut off overnight. As production continued, so did the impact of financial market influence on crude prices, and as a result, storage tanks filled up faster than expected. By April 2020, the U.S. benchmark oil price, West Texas Intermediate (WTI), actually dropped below zero. In simple terms, traders had to pay others to take their oil because there was no space left to store it.
This unusual moment revealed that it’s not just about how much oil is produced or consumed, but also about where and how it’s stored. In times of crisis, logistics can influence prices as strongly as supply and demand.
The event also highlighted the appeal and the risk of the crude oil storage trade. When future prices are higher than current prices, traders can buy oil cheaply, store it, and sell it later for a profit. But that strategy only works while storage space remains available. When everyone tries to do it once, storage fills up, costs rise sharply, and profits vanish.
Why the Storage Trade Matters for Oil Investment?
For large investors, storage trade helps stabilize prices and manage risk during volatile periods. Hedge funds and energy companies use it to hedge future positions or profit from price spreads.
Retail investors can also learn from it. Understanding how storage influences pricing cycles can help you make more informed decisions about when to enter or exit crude oil investments.
Risks of Storage-Based Trading Strategies
-
High Capital Requirements: Renting storage tanks or tankers is expensive. During periods of low demand or price volatility, high capital requirement costs can become burdensome, which in turn could erode profit margins. Companies, thus, must maintain strong financial reserves to handle such expenses and stay competitive in an unpredictable market.
-
Limited Storage Availability: Space can run out quickly, as seen in 2020, when oil demand collapsed and oil inventories surged. Crude was stored in tankers at sea or paid to others to take the excess supply.
-
Market Volatility: Unexpected demand changes or geopolitical events can wipe out expected profits. Crude oil prices are highly sensitive to global tensions. From supply chain disruptions to economic shifts, market volatility makes it difficult for traders to predict outcomes. Hence, effective risk management and hedging strategies are crucial to withstand sudden market shocks.
How Retail Investors Can Gain Indirect Exposure?
Most individual investors can’t store barrels of crude oil in their backyard. But they can still gain exposure to oil price movements through financial instruments that mirror oil’s performance, such as ETFs, ETNs, or energy-sector funds.
-
ETFs Tracking Futures: Exchange-traded funds (ETFs) and exchange-traded notes (ETNs) allow investors to participate in the oil market without trading futures directly. ETFs like the United States Oil Fund (USO) hold crude oil futures to track oil prices, but when markets are in contango, these funds lose value over time. It’s due to the cost of rolling contracts, known as negative roll yield.
ETNs such as iPath Series BS & P GSCI Crude Oil ETB (OIL) work differently. They’re debt instruments tied to oil indexes. ETNs avoid tracking errors but carry issuer risk, since their value depends on the bank behind them. ETFs suit short-term speculation, while ETNs can be more tax-efficient but riskier if the issuer defaults.
-
Energy Stocks and Sector ETFs: Another way to gain oil exposure is through energy stocks and sector-focused ETFs, which move in response to oil prices but are grounded in company performance. The Energy Select Sector SPDR Fund (XLE) tracks U.S. oil majors like ExxonMobil and Chevron, while the iShares Global Energy ETF (IXC) includes global firms like Shell and BP. There are also specialized funds targeting specific segments (exploration, refining, or oilfield services) such as XOP, CRAK, and OIH.
-
Diversified Energy Funds: For investors seeking balance, diversified energy funds offer broader exposure across exploration, production, refining, and logistics. These funds help spread risk to provide a steadier way to participate in energy market cycles without being tied solely to crude oil’s price volatility. They also reflect the interconnected nature of the energy economy, where oil storage, transport, and production all move together to shape returns.
Conclusion
The 2020 oil price crash revealed that energy markets run on more than just supply and demand. They run on storage, timing, and logistics. Understanding the importance of crude oil storage trade offers valuable insights into how physical realities shape financial outcomes. While most retail investors can’t store oil themselves, they can still participate indirectly through ETFs, ETNs, or energy-sector funds.
In the end, smart energy investing isn’t only about predicting prices. It’s more about understanding the system that moves them.
FAQs
Why did oil prices go negative in 2020?
Because storage ran out, and sellers were willing to pay buyers to take oil off their hands. The unprecedented collapse in demand from the pandemic thus left traders with nowhere to store excess crude, forcing prices below zero for the first time in history.
Can individual investors profit from the crude oil storage trade?
Directly, no. But, if it’s indirectly through ETFs or oil-related companies, then yes. However, if it’s an individual investor, one can gain exposure to oil price movements via energy sector stocks, futures-based funds, or even storage and logistics firms that benefit from market imbalances. But, these investments still carry significant volatility and require careful timing.
What does contango mean in crude oil investment?
It’s when future prices are higher than current prices, making storage potentially profitable.
How does oil storage affect prices globally?
Storage acts as a buffer. When it’s abundant, prices can remain low longer; when it’s scarce, prices rise faster.