WeWork Gets SPAC’d

In 2021, SPACs were the hottest trend on the stock market and had become the leading way for companies to go public. A public company is one with shares that trade on the stock market. Private firms make up more than 95 percent of all firms in the United States. Most will never become public firms because they will never grow large enough for investors to have sufficient information on the firms’ financial health to be willing to buy the firms’ stocks and bonds.

But some firms, particularly technology firms, grow rapidly enough that they are able to become public firms. Apple, Microsoft, Google, Uber, Facebook, Snap, and other firms have followed this path. When these firms went public, they did so using an initial public offering (IPO). (We briefly discuss IPOs in Economics and Microeconomics, Chapter 8, Section 8.2 and in Macroeconomics, Chapter 6, Section 6.2.) With an IPO, a firm uses one or more investment banks to underwrite the firm’s sales of new stocks or bonds to the public. In underwriting,investment banks typically guarantee a price for stocks or bonds to the issuing firm, sell the stocks or bonds in financial markets or directly to investors at a higher price, and keep the difference, known as the spread.

Beginning in 2020 and continuing through 2021, an increasing number of firms have used a different means of going public—merging with a SPAC. SPAC stands for special-purpose acquisition company and is a firm that holds only cash—it doesn’t sell a good or service—and only has the purpose of merging with another firm that wants to go public. Once a merger takes place, the acquired firm takes the place of the SPAC in the stock market. For instance, a SPAC named Diamond Eagle Acquisition merged with online sports betting site DraftKings in April 2020. Once the merger had been completed, DraftKings took Diamond Eagle’s place on the stock market, trading under the stock symbol DKNG. By 2021, the value of SPAC mergers had risen to being three times as much as the value of IPOs.

Some firms intending to go public prefer SPACs to traditional IPOs because they can bargain directly with the managers of the SPAC in determining the value of the firm. In addition, IPOs are closely regulated by the federal government’s Securities and Exchange Commission (SEC). In particular, the SEC monitors whether an investment bank is accurately stating the financial prospects of a firm whose IPO the bank is underwriting. The claims that SPACs make when attracting investors are less closely monitored. SPAC mergers can also be finalized more quickly than can traditional IPOs.

The experience of WeWork illustrates how some firms that have struggled to go public through an IPO have been able to do so by merging with a SPAC. Adam Neumann and Miguel McLevey founded WeWork in 2010 as a firm that would rent office space in cities, renovate the space, and then sub-lease it to other firms. In 2019, the firm prepared for an IPO that would have given the firm a total value of more than $40 billion. But doubts about the firm’s business model led to an indefinite postponement of the IPO and Neumann was forced out as CEO.

WeWork was reorganized under new CEO Sandeep Mathrani and went public in October 2021 by merging with BowX Acquisition Corporation, a SPAC. Although WeWork’s stock began trading (under stock symbol WE) at a price that put the firm’s value at about $9 billion—far below the value it expected at the time of its postponed IPO two years before—investors seemed optimistic about the firm’s future because its stock price rose sharply during the first two days it traded on the stock market. 

Some policymakers are concerned that individual investors may not have sufficient information on firms that go public through a merger with a SPAC. Under one proposal being considered by Congress, financial advisers would only be allowed to recommend investing in SPACs to wealthy investors. The SEC is also considering whether new regulations governing SPACS were needed. Testifying before Congress, SEC Chair Gary Gensler sated: “There’s real questions about who’s benefiting [from firms going public using SPACs] and [about] investor protection.” 

It remains to be seen whether SPACs will retain their current position as being the leading way for firms to go public.

Sources: Dave Sebastian, “WeWork Shares Rise on First Day of Trading, Two Years After Failed IPO,” wsj.com, October 21, 2021; Peter Santilli and Amrith Ramkumar, “SPACs Are the Stock Market’s Hottest Trend. Here’s How They Work,” wsj.com, March 29, 2021; Benjamin Bain, “SPAC Marketing Heavily Curtailed in House Democrats’ Draft Bill,” bloomberg.com, October 4, 2021; and Dave Michaels, “SEC Weighs New Investor Protections for SPACs,” wsj.com, May 26, 2021.

The Wild Ride of GameStop’s Stock Price

Supports:  Hubbard/O’Brien, Chapter 8, Firms, the Stock Market, and Corporate Governance; Macroeconomics Chapter 6; Essentials of Economics Chapter 6; Money, Banking, and the Financial System, Chapter 6.

We’ve seen that a firm’s stock price should represent the best estimates of investors as to how profitable the firm will be in the future. How, then, can we explain the following graph of the price of shares of GameStop, the retail chain that primarily sells video game cartridges and video game systems? The graph shows the price of the stock from December 1, 2020 through February 9, 2021. If the main reason the price of a stock changes is that investors have become more or less optimistic about the profitability of the firm, is it plausible that opinions on GameStop’s profitability changed so much in such a short period of time?.

  Sometimes investors do abruptly change their minds about the profitability of a firm but typically this happens when the firm’s profitability is heavily dependent on the success of a single product. For instance, the price of the stock a biotech firm might soar as investors believe that a new drug therapy the firm is developing will succeed and then the price of the stock might crash when the drug is unable to gain regulatory approval.  But it wasn’t news about its business that was driving the price of GameStop’s stock from $15 per share during December 2020 to a high of $347 per share on January 27, 2021 and then down to $49 per share on February 9.

            To understand these prices swings, first we need to take into account that not all people buying stock do so because they are making long-term investments to accumulate funds to purchase a house, pay for their children’s educations, or for their retirement. Some people who buy stock are speculators who hope to profit by buying and selling stock during a short period—perhaps as short as a few minutes or less. The availability of online stock trading apps, such as Robinhood, that don’t charge commissions for buying and selling stock, and online stock discussion groups on sites like Reddit, have made it easier for some individual investors to become day traders, frequently buying and selling stocks in the hopes of making a short-term profit.

Many day traders engage in momentum investing, which means they buy stocks that have increasing prices and sell stocks that have falling prices, ignoring other aspects of the firm’s situation, including the firm’s likely future profitability. Momentum investing is an example of what economists call noise trading, or buying and selling stocks on the basis of factors not directly related to a firm’s profitability. Noise trading can result in a bubble in a firm’s stock, which means that the price rises above the fundamental value of the stock as indicated by the firm’s profitability. Once a bubble begins, a speculator may buy a stock to resell it quickly for a profit, even if the speculator knows that the price is greater than the stock’s fundamental value. Some economists explain a bubble in the price of a stock by the greater fool theory: An investor is not a fool to buy an overvalued stock as long as there’s a greater fool willing to buy it later for a still higher price. 

Although the factors mentioned played a role in explaining the volatility in GameStop’s stock price, there was another important factor that involved hedge funds and short selling. Hedge funds are similar to mutual funds in that they use money from savers to make investments. But unlike mutual funds, by federal regulation only wealthy individuals or institutional investors such as pension funds or university endowment funds are allowed to invest in hedge funds. Hedge funds frequently engage in short selling, which means that when they identify a firm whose stock they consider to be overvalued, they borrow shares of the firm’s stock from a broker or dealer and sell them in the stock market, planning to make a profit by buying the shares back after their prices have fallen.

In early 2021, several large hedge funds were shorting GameStop’s stock believing that the market for video game cassettes would continue to decline as more gamers switched to downloading games. Some people in online forums—notably the WallStreetBets forum on Reddit—dedicated to discussing investing strategies argued that if enough day traders bought GameStop’s stock they could make money through a short squeeze. A short squeeze happens when a heavily shorted stock increases in price. The speculators who shorted the stock may then have to buy back the stock to avoid large losses or having to pay very high fees to dealers who had loaned them the shares they were shorting. As the short sellers buy stock, the price of the stock is bid up further, earning a profit for day traders who had bought the stock in anticipation of the short squeeze. One MIT graduate student made a profit of more than $200,000 on a $500 investment in GameStop stock. Some hedge funds that had been shorting GameStop lost billions of dollars.

Some of the day traders involved saw this episode as one of David defeating Goliath because the people executing the short squeeze were primarily young with moderate incomes whereas the people running the hedge funds taking substantial losses in the short squeeze were older with high incomes. The reality was more complex because as the price of GameStop stock declined from $347 on to $54 on February 4, some day traders who bought the stock after its price had already substantially risen lost money. And all the winners from the short squeeze weren’t day traders; some were hedge funds. For instance, by early February, the hedge fund Senvest Management had earned $700 million from its trading in GameStop’s stock.  

Economists had differing opinions about whether the GameStop episode had a wider significance for understanding how the stock market works or for how it was likely to work in the future. Some economists and investment professionals argued that what happened with GameStop’s stock price was not very different from previous episodes in which speculators buying and selling a stock will for a time cause increased volatility in the stock’s price. In the long run, they believe that stock prices return to their fundamental values. Other economists and investors thought that the increased number of day traders combined with the availability of no-commission stock buying and selling meant that stock prices might be entering a new period of increased volatility. They noted that similar, if less spectacular, price swings had happened at the same time in other stocks such as AMC, the movie theater chain, and Express, the clothing store chain. An article on bloomberg.com quoted one analyst as saying, “We’ve made gambling on the stock market cheaper than gambling on sports and gambling in Vegas.” 

            Federal regulators, including Treasury Secretary Janet Yellen, were evaluating what had happened and whether they needed to revise existing government regulations of financial markets.  

Sources: Misyrlena Egkolfopoulou and Sarah Ponczek, “Robinhood Crisis Reveals Hidden Costs in Zero-Fee Trading Model,” bloomberg.com, February 3, 2021; Gunjan Banerji,  Juliet Chung, and Caitlin McCabe, “GameStop Mania Reveals Power Shift on Wall Street—and the Pros Are Reeling,” Wall Street Journal, January 27, 2021; Gregory Zuckerman, “For One GameStop Trader, the Wild Ride Was Almost as Good as the Enormous Payoff,” Wall Street Journal, February 3, 2021; Juliet Chung, “Wall Street Hedge Funds Stung by Market Turmoil,” Wall Street Journal, January 28, 2021; and Juliet Chung, “This Hedge Fund Made $700 Million on GameStop,” Wall Street Journal, February 3, 2021. 

           

Questions 

  1. During the same week that the price of GameStop’s stock was soaring to a record high, an article in the Wall Street Journal noted the following: “Analysts expect GameStop to post its fourth consecutive annual decline in revenue in its latest fiscal year amid declines in its core operations [of selling video game cartridges and video game consoles in retail stores].” Don’t stock prices reflect the expected profitability of the firms that issue the stock? If so, why in January 2021 was the price of GameStop’s stock greatly increasing when it seemed unlikely that the firm would become more profitable in the future?

Source: Sarah E. Needleman, “GameStop and AMC’s Stocks Are on a Tear, but Their Businesses Aren’t,” Wall Street Journal, January 31, 2021

2. In early 2021, as the stock price of GameStop was soaring, a columnist in the New York Times advised that: “A better option [than buying stock in GameStop] would be salting away money in dull, well-diversified stock and bond portfolios, these days preferably in low-cost index funds.”

a. What does the columnist mean by “salting money away”?

b. are index funds and why might they be considered dull when compared to investing in an individual stock like GameStop?

c. Why would the columnist consider investing in an index mutual fund to be a better option than investing money in an individual stock like GameStop? 

Source: Jeff Sommer, “How to Keep Your Cool in the GameStop Market,” New York Times, January 29, 2021.

Instructors can access the answers to these questions by emailing Pearson at christopher.dejohn@pearson.com and stating your name, affiliation, school email address, course number.

COVID-19 Update – If the Economy Is Down, Why Is the Stock Market Up?

Supports:  Econ (Chapter 8 – Firms, the Stock Market, and Corporate Governance; Micro (Chapter 8): Macro (Chapter 6); Essentials: Chapter 6.

Apply the Concept:  If the Economy Is Down, Why Is the Stock Market Up?

Here’s the Key Point:  In determining a firm’s stock price, the firm’s current profitability is less important than its expected future profitability.

The price of a share of stock reflects the profitability of the firm that issued it.  During economic recessions, firms experience declining sales and profits and the prices of their stocks fall.  We saw such a decline at the beginning of the downturn caused by the Covid-19 pandemic in 2020.   As the following figure shows, the S&P 500 stock market price index reached a high the week ending on February 14. By the week ending on March 20, this index had declined by 29 percent.

On the figure, the shaded area shows the weeks during this period when the economy was in a recession. We are dating the beginning of the recession using the Weekly Economic Index published by the New York Federal Reserve and compiled by James Stock of Harvard, Daniel Lewis of the New York Federal Reserve, and Karel Mertens of the Dallas Federal Reserve. The index is comprised of 10 economic variables including sales in retail stores, claims by laid off workers for government unemployment insurance payments, steel production, and railroad freight traffic.

            Notice two things about the figure:

  1. Stock prices began to fall in mid-February 2020, about a month before the recession began in mid-March.  This result is not surprising because the stock market is often a leading indicator, that is, stock prices tend to decline before production and employment fall.  The incomes of professional stock traders and managers of mutual funds and exchange-traded funds (ETFs) depend in part on their ability to sell stocks before their prices decline and buy them before their prices increase. So these finance professionals have a strong incentive to attempt to anticipate changes in the economy before they occur.
  2. Stock prices began to rise in mid-March while the economy was still in recession. In fact, the S&P 500 stock index increased more than 20 percent between mid-March and early May even though, as measured by the WEI, the economic recession was becoming worse as production and employment were rapidly declining. This result surprised many people who had trouble understanding how, as the headline of an article in the New York Times put it: “The Bad News Won’t Stop, but Markets Keep Rising.”

Both these points reflect the same key fact about the stock market:  Although a firm’s stock price depends on the firm’s profitability, the firm’s current profitability is less important than its expected future profitability.  You wouldn’t pay much for the stock of a firm that was making a profit today but that you expect will be driven out of business in the future by another firm about to introduce a superior competing product.  Even though the profitability of most firms in the United States had yet to decline in mid-February, many investors were beginning to fear that Covid-19 would have a major effect on the U.S. economy, so stock prices began to decline.

      Why then did stock prices turnaround and begin to rise only a month later, and why did they rise and fall significantly on many days?  Those swings in stock prices reflected a key result of investors interacting in financial markets: Buying and selling of financial assets like stocks results in the prices of those assets fully reflecting all the available information relevant to the value of the assets.  In the case of the stock market, buying and selling stock results in stock prices reflecting all available information on the future profitability of the firms issuing the stock.  New information that is favorable to the future profitability of a firm—for instance, Apple announces that iPhone sales have been higher than investors expected—will lead investors to increase demand for the firm’s stock, raising its price. The opposite happens when new information becomes available that is unfavorable to the future profitability of a firm.

Because new information becomes available continually, we would expect stock prices to change day-to-day, hour-to-hour, and minute-to-minute.  Stock prices for the market as a whole, as reflected in stock price indexes like the S&P 500, will rise and fall as new information becomes available on the future strength of the economy. During the Covid-19 pandemic, investors were particularly concerned with the following four issues:

  1. The development of new medical treatments for the disease, particularly vaccines.
  2. The effectiveness of government programs, such as loans to businesses, that were intended to help the economy recover from the effects of the lockdowns used to reduce the spread of the virus.
  3. The ability of the economy to adjust to the possibility that the virus might persist in some form for years.
  4. The willingness of consumers to resume buying goods and services, such as restaurant meals and movie tickets, that seemed particularly affected by the virus.

Optimistic news about these factors, such as successful early trials of a vaccine for use against Covid-19, caused sharp increases in stock prices and pessimistic news caused prices to fall.  For example, here are the percentage changes in the S&P 500 stock price index for consecutive trading days in mid-March (the stock market is closed on Saturdays and Sundays):

Stock prices are rarely this volatile. Wall Street investment professionals spend a great deal of effort gathering all possible information about the future profitability of firms, but in this period they had difficulty interpreting the importance of new information. No investor had experienced a pandemic as severe as Covid-19, so it was particularly challenging for them to determine the implications of new information for the likely future strength of the economy and, therefore, to the profitability of firms.

The large fluctuations in stock prices were another indication of how unusual an event the Covid-19 pandemic was and the difficulty that investors had in understanding its likely long-run effects on the U.S. economy.

Sources: Matt Phillips, “The Bad News Won’t Stop, but Markets Keep Rising,” New York Times, April 29, 2020; and Federal Reserve Bank of St. Louis.              

Question:

In May 2020, an article in New York Magazine noted that, “The stock market zoomed on Monday in response to very preliminary positive news about a vaccine” being tested by the pharmaceutical firm Moderna.  Positive news about one of its products might be expected to increase Moderna’s future profits and the price of its stock, but why would prices of many other stocks increase on this news?

For Economics Instructors that would like the approved answers to the above questions, please email Christopher DeJohn from Pearson at christopher.dejohn@pearson.com and list your Institution and Course Number.

COVID-19 Update – The Futures Market and the Strange Case of Negative Price of Oil.

Supports:  Econ and Micro: Chapter 8, “Firms, the Stock Market, and Corporate Governance” Macro Chapter 6; Essentials Chapter 6

The Futures market and the strange case of negative price of oil

There’s a point that seems so obvious that we haven’t explicitly mentioned it until now:  The price of a good or service is always positive. After all, a price being negative means that a seller is paying a buyer to accept a good or service, which seems very unlikely.  But this strange outcome did occur in the U.S. oil market during the economic upheaval caused by the coronavirus pandemic of 2020.

            In the spring of 2020, there were two important developments in the world oil market:

  1. A sharp decline in demand   Many countries imposed social-distancing protocols and required non-essential business to shut down in response to the pandemic.   These policies caused the demand for oil products to decline dramatically. For instance, in the United States, the demand for gasoline fell by about 50 percent between the middle of March and the middle of April. The decline was the largest in history over such a short period.
  2. A decline in world supply   Twenty-three countries, including the United States, Russia, and Saudi Arabia—the world’s three largest oil producer—agreed to reduce oil production by 9.7 million barrels per day, or about 13 percent of daily world production. These countries  hoped that the decline in supply would keep the world price of oil from falling to very low levels.  In fact, though, through mid-April the decline in demand was larger than the decline in supply leading to a dramatic decline in oil prices.

Crude oil from different rock formations can vary in its characteristics, such as its sulfur content.  Crude oil that requires more processing as it is being refined into gasoline, aviation fuel, or other products, sells for a lower price. The benchmark oil price in the United States is for a grade of crude oil called West Texas Intermediate.  The following figure shows the fluctuations in the price per barrel of this type of oil from January 2018 through late April 2020.

After reaching a high of $63 per barrel in January 2020, the price of oil declined to negative $37 per barrel on April 20.  In other words, sellers were willing to pay buyers $37 per barrel to accept delivery of oil.  Why would a seller ever pay someone to accept a product?  There are two related reasons. We can discuss the first reason using demand and supply analysis. The second reason requires a brief discussion of how the oil market is different from most other markets for goods.

Demand and Supply in the Spot Market for Oil

            To understand how movements in demand and supply in the oil market resulted in a negative price, consider the following figure illustrating this situation. Before the coronavirus pandemic, the demand for oil is shown by demand curve D1 and the supply of oil by supply curve S1. The equilibrium price is P1.  During the pandemic, the amount of oil demanded declined sharply from D1 to D2, and the supply of oil declined from S1 to S2.  As a result, the new equilibrium price became negative at P2.  We can see that for the equilibrium price to be negative, the demand curve and supply curve must intersect below the horizontal axis.  

But why would a firm be willing to supply any oil at a negative price?  The answer requires  understanding how oil markets work.  The spot price of oil is the price for oil that is available for immediate delivery.  A seller at the spot price is typically a firm pumping oil, and a buyer is a firm that uses oil as an input, such as a firm that refines oil into gasoline.  When you buy bread in the supermarket or a Big Mac at McDonald’s you are paying the spot price, which is the only price in the markets for most goods and services. In the figure we are showing the spot market for oil and the price is the spot price.

The Futures Market for Oil

But in addition to a spot market for oil, there is a futures market for oil, which allows individuals and firms to buy and sell futures contracts.  A futures contract specifies the quantity of an asset—such as a barrel of oil—that will be delivered by the seller on a future date, the settlement date. Futures contracts exist for commodities such as oil, as well as for financial assets, such as Treasury bonds and stock indexes like the S&P 500. Futures contracts don’t set the price—the futures price—that the buyer will pay and the seller will receive on the settlement date. Instead, the price fluctuates as the contract is bought and sold on a futures exchange, such as the Chicago Board of Trade or the New York Mercantile Exchange, just as the price of a share of stock fluctuates as the stock is bought and sold in the stock market.  Each oil futures contract represents 1,000 barrels (or 42,000 gallons) of oil.

The futures price of oil can differ from the spot price if people trading futures contracts expect that conditions in the oil market will differ on the settlement date from conditions today. For instance, on April 20, 2020, the date on which the spot price of oil was negative, the oil futures price on a contract with a settlement date in June was $22 per barrel and the price on a contract with a settlement date in November was $33 per barrel.  The higher oil prices for June and November reflected the view among buyers and sellers and futures contracts that (1) the economy was likely to begin recovering from the worst of the pandemic by then, increasing the demand for oil and (2)  the supply of oil was likely to decline further.

The spot price and the futures price are linked because it’s possible to store oil. So, the futures price should roughly equal the spot price plus the cost of storing oil between today and the settlement date of the futures contract. As the settlement date approaches, the futures price comes closer to the spot price, eventually equaling the spot price on the settlement date. Why must the spot price equal the futures price on the settlement date? Because if there were a difference between the two prices, it would be possible for an investor to make a profit. For instance, if the spot price of oil was $35 on the settlement date of the futures contract but the futures price was $40, an investor could buy oil on the spot market and simultaneously sell futures contracts. The buyers of the futures contract would have to accept delivery of oil at $40, which would allow the investor to make a risk-free profit of $5 per barrel. In practice, investors selling additional futures contracts would drive down the futures price until it equaled the spot price. Only then would the ability to make a profit disappear.

Unlike with the spot market, buyers and sellers in the futures market may not be involved with either pumping or using oil. Instead, they may be investors who hope to profit by placing a bet on which way the price of oil will change in the future. These market participants are called speculators.  Speculators serve the useful purpose of adding to the number of buyers and sellers in the futures market, thereby increasing market liquidity, which is the ease with which a buyer or seller can sell an asset, such as a futures contract.

You can speculate on the price of oil using the futures market in oil. If you believe that the futures price is lower than the spot price of oil will be on the settlement date, you can hope to make a profit by buying futures contracts today and selling them after the price rises. Similarly, if you believe that the futures prices is higher than the price of oil will be in the spot market on the settlement date, you can sell futures contracts at the current high price and  buy them back after the price has fallen. It’s important to understand that investors doing this type of buying and selling of futures contracts don’t expect to actually deliver or receive barrels of oil.

What Happened in the Oil Market in April 2020?

Ordinarily, when firms pumping oil expect prices to be significantly higher in the future, they can respond by withholding oil from the market in several ways: (1) They can reduce the quantity of oil they pump, in effect storing it in the ground until prices increase; (2) they can pump oil and store it until prices rise; and (3) they can store oil products like gasoline that are refined from oil on supertankers, which are capable of holding millions of barrels of oil, waiting for prices to rise.

But in the spring of 2020, the decline in demand was so large and so sudden that firms were uncertain how much to reduce the quantity of oil they were pumping.  If the decline in demand was temporary, lasting only during the worst of the pandemic, firms that cut back too much would face both the cost of both closing and then reopening oil wells.  In some cases, even temporarily stopping production from a well can permanently reduce how much oil can be recovered from the well. In addition, the usual places to store oil were rapidly reaching capacity.  As an article in the Wall Street Journal put it: “The buildup of crude is overwhelming storage space and clogging pipelines. And in areas where tanker-ship storage isn’t readily available, producers could need to go to extremes to get rid of the excess.” The “extremes” included accepting negative prices. 

On April 20, there was a second factor pushing oil prices into negative values. The May futures contract was expiring the next day, meaning that any buyer who had not sold the contract would legally have to pay for and accept delivery of 1,000 barrels of oil.  As we’ve seen, some buyers and sellers of oil futures contracts are speculators who don’t intend to deliver or receive barrels of oil.  Given the shortage of storage facilities, rather than accept delivery for oil with nowhere to put it, speculators were willing to take steep losses by selling their contracts at a negative price.  In effect, a buyer of a contract received $37,000 ($37 per barrel × 1,000 barrels per contract) in addition to 1,000 barrels of oil—a great deal, but only if you had somewhere to store the oil.

If oil producers become convinced that the decline in demand is likely to be long-lived, they will reduce the supply of oil substantially and the spot price will rise enough to ensure that the producers are able to cover all of their costs.  But the fact that the spot price of oil was briefly negative indicates the level of economic disruption the coronavirus caused.

Sources: Ryan Dezember, “U.S. Oil Costs Less Than Zero After a Sharp Monday Selloff,” Wall Street Journal, April 21, 2020; Neil Irwin, “What the Negative Price of Oil Is Telling Us,” New York Times, April 21, 2020; Myra P. Saefong, “Oil Market in ‘Super Contango’ Underlines Storage Fears as Coronavirus Destroys Crude Demand,” marketwatch.com, April 18, 2020; Benoit Faucon, Summer Said, and Timothy Puko, “U.S., Saudi Arabia, Russia Lead Pact for Record Cuts in Oil Output,” Wall Street Journal, April 12, 2020; Federal Reserve Bank of St. Louis; and U.S. Energy Information Administration.

Question: 

  1. If a futures market for oil didn’t exist,  would the spot price of oil ever be negative?
  2. If you were a manager of a firm that owns oil wells, how would you benefit from the existence of a futures market for oil? If you were a manager of a firm that buys oil to refine into gasoline, how would you benefit from the existence of a futures market for oil?

For Economics Instructors that would like the approved answers to the above questions, please email Christopher DeJohn from Pearson at christopher.dejohn@pearson.com and list your Institution and Course Number.