[Desk Column] Water Prices, Oil Prices, Contango, and Mudaeppo

[Asia Economy Reporter Jeon Pil-su] An era where oil is cheaper than water. It might seem like the media sensationalized the headline because oil prices have fallen so much, but in reality, based on international oil prices, crude oil is cheaper than bottled water sold at large supermarkets. Since 1 barrel equals 158.9 liters, even at $20 per barrel, the price of crude oil is about 155 won per liter (based on an exchange rate of 1,232 won).

Investors are buzzing over this strange phenomenon caused by the plunge in international oil prices. In particular, the news that the West Texas Intermediate (WTI) crude oil futures price in the U.S. dropped into negative territory has caught the attention of investors who previously showed little interest. Even acquaintances who have never properly invested in derivatives or stocks are asking, “Shouldn’t we buy oil-related products now?”

To confess, I was also shaken by the news of the WTI futures price turning negative. Considering the investment adage, “There is no better opportunity than a crash,” the situation where futures prices fell below zero certainly looked like an opportunity. I thought, “Surely such abnormal prices won’t last?” It reminded me of the situation when the domestic stock market crashed last month.

However, unlike spot prices, futures?which are the basis of derivatives?mostly have an “expiration date.” The May WTI futures, which fell to minus $37 on the 20th, expired on the 21st. Derivatives based on WTI must be rolled over from the May contract to the June contract. This process is called a roll-over, but the problem is that the June futures price is higher than the May futures price. This situation, where the new futures price is higher than the expiring futures price, is called contango, and it results in roll-over costs.

The problem arises when the expiring futures price has plummeted so much, causing a large price gap, creating a super contango situation. A securities expert explained, “The roll-over cost for the May WTI futures just before it dropped into negative territory was 15-20%. In cases like now, roll-over costs can exceed 30% depending on the product.”

These roll-over costs are directly passed on to the product prices. Even if international oil prices rise again, considering these additional costs, the actual returns to investors inevitably decrease. When international oil prices rebounded 30% at the beginning of the year, the return on oil-linked exchange-traded funds (ETFs) listed in the U.S. was only about 5%. This means that simply waiting with the thought “It will go up someday” does not guarantee profits.

Individual investors who bravely jumped in during last month’s crash actually made considerable profits. Their investment was based on faith in the excessively plummeted stock prices relative to intrinsic value. Even without much knowledge of stocks, their strategy was simple but classic: buying when Samsung Electronics fell to liquidation value levels and when the stock price of the top domestic financial holding company with the number one bank was below 30% of liquidation value.

However, it is inappropriate to apply such strategies to derivatives, which have completely different product structures. Highly volatile derivatives are not general investment tools for ordinary investors but rather speculative products for experts. Most investors in oil ETFs and exchange-traded notes (ETNs) bet on price fluctuations lasting only a day or two at most.

Participating in such a market simply because it looks cheap is like going to a battlefield without a gun?a reckless spirit. The term “reckless spirit” (mudaepo) originates from the Battle of Nagashino during Japan’s Sengoku period, where the Takeda cavalry, once the strongest mounted force, charged headlong into Oda’s arquebus units and were almost annihilated. It is worrisome that the top net purchase stock by individuals in the KOSPI market this month is KODEX WTI Crude Oil Futures (H).

This content was produced with the assistance of AI translation services.