We know why you are here. You want either want to make money off the oil crisis and/or understand the oil crisis.
If you want to get straight into the strategies then scroll past the ‘why did oil drop section’.
Why did oil drop to $0 and into the negatives?
Essentially, oil plummeted to $0 and into the negatives because the demand collapsed. The combination of travel coming to a screeching halt, the coronavirus lockdown, and the Russia-Saudia Arabia oil crisis were the critical factors in driving down the demand. However, the real problem is that producers are still pumping out a lot of oil. Therefore, if we look at supply and demand, basic economics, there is an oversupply of oil because of the lack of demand. Just imagine the red line being pushed further into the left-hand corner (decreasing the price).
There's been an extraordinary collapse in the price of oil in the United States with crude dropping below $1 a barrel, and at one point even going negative for the first time ever. pic.twitter.com/D7pRFL6et7
— Channel 4 News (@Channel4News) April 20, 2020
Producers are producing too much oil that their storage facilities are almost full. Also, the Russia-Saudia Arabia oil crisis increased the supply. Now, you might be asking yourself, why don’t oil producers reduce supply to achieve equilibrium?
I answer that by saying it is not that simple to shut down an oil company and then return to business as usual. Oil companies, much like the economy, are not a light switch. The coronavirus lockdown is exposing the harsh reality that shutting down businesses is like freezing the blood flow in the human economy. Thus, oil producers are not going to shut down. They anticipate oil prices to stabilise around the $25-$35 range in the coming months. Even if that means selling barrels of oil at a loss in the short-term.
An important concept to understand - Futures
Furthermore, investors trade oil using monthly contracts called futures. When someone buys a future, they agree to receive a physical delivery of oil every month. Traders often buy futures and then resell them to buyers, who will receive the oil, to make a profit. However, if the trader cannot find a buyer before the contract expires, they physically receive the barrel. Traders often find a buyer because they are not looking to store oil in their house.
However, the decrease in demand means there are fewer buyers of oil. Consequently, investors and producers must receive the barrel of oil physically. Yesterday (April 21st) , was the day that May Oil Futures expired. Hence, the owners of future oil contracts all sold off their positions, causing the plunge in prices.
Oil is trading below $0 a barrel across the U.S. after the futures market suffered its worst price crash in history https://t.co/IRMkwzRL8i
— Bloomberg (@business) April 20, 2020
How can you profit off the oil crisis?
Before I start, I am obliged to remind our viewers that this is not advice only general commentary from my extensive research in this area.
Ever since oil plunged into the negatives, the immediate reaction was to buy, buy, and buy. Even your uber driver probably said buy. Why wouldn’t you yes say to people paying you to take oil off their hands? Unfortunately, the average investor cannot just go up to the company to purchase an endless number of barrels. Because where would they store all the barrels.
Investing in oil now is based on the basic strategy ‘Buy low sell high’. The demand for oil is extremely low now. However, once countries re-open, travel returns to normal, and the economy recovers from the COVID-19 crash, then the demand for oil should surge. Thus, supporting the hypothesis that investing in oil now should provide a healthy return in the future (opinion not advice).
I would not pounce on oil immediately. If I were investing in oil I would use catalyst indicators (CI’s). CI’s are events that confirm the future trend of oil.
Demand Catalyst indicators = Price of oil should spike
- Countries relaxing social distancing measures
- Businesses completely reopening
- Travel returning to normal
Supply Catalyst indicators = Price of oil should spike
- Countries are reducing their supply of oil e.g., OPEC agreements or countries pausing, not shutting down, production.
- Producers are dumping more oil into the market.
1) Invest in oil companies
I would strongly recommend against investing in oil futures. Instead, steering towards oil companies, ETF’s, and ETCs is the way to go. (opinion not advice)
Oil giants are likely to come out on the other side of the COVID-19 tunnel. The companies below should not go bankrupt as they are the driving forces in fueling GDP growth for Australia and America. Also, oil giants are accustomed to the volatility in the oil market, are well protected with their gigantic cash reserves and pay huge dividends. Thus, the strategy is to let the oil crisis beat down these industry giants to an attractive discount, jump in, and ride the rollercoaster of long-term growth.
- Exxon Mobil Corp (NYSE: XOM)
- Chevron Corp (NYSE: CVX)
- BP (NYSE: BP)
- Shell (NYSE: RDS.A)
- BHP Group Ltd (ASX: BHP)
2) Invest in ETFs and ETCs
Investing in Exchange-Traded Funds, in my opinion, is the best strategy to profit off the oil crisis. An ETF in this scenario is a collection of oil companies that aim to track the performance of an oil index such as e.g West Texas Intermediate. Oil ETF’s take out the headache of trying to find the best oil stock to invest in. Thus, the strategy is to wait until the catalyst indicators above show signs of recovery, jump in, and ride the long-term upward trend.
I have my eyes set on the following ETFs:
- SPDR MSCI World Energy UCITS ETF (WNRG)
- Beta Shares crude Oil ETF (ASX: OOO)
An alternative investment strategy for riskier investors include Exchange-Traded Commodities (ETCs). ETCs track the buying/selling of oil futures instead of an oil index. Two possible ETCs to look at include:
- ProShares UltraShort Bloomberg Crude Oil (ARCX: SCO) = leverages the downward movements in oil = If oil futures is likely to go down you invest in SCO (opinion not advice).
- ProShares Ultra Bloomberg Crude Oil (ARCX: UCO) leverages the upward movements in oil = If oil futures are likely to go up you invest in UCO (opinion not advice).
Future Outlook on Oil.
The future direction of the oil crisis is uncertain. However, all signs are pointing towards a prolonged recessionary oil market. In which oil prices stay extremely low over the imminent future. Especially, as businesses stay shutdown, travel restrictions continue, and the Russia-Saudi Arabi oil crisis remains alive.
However, oil prices will undoubtably rebound. Donald Trump is diligently working to ensure the oil and gas industries recover from the crisis. Trump is initiating the following measures:
- Creating a bailout plan for the U.S oil industry
- Facilitating discussions between Russia and Saudi Arabia to reduce their supply
- Purchasing 75 million barrels of oil for the government’s national reserve
Trump says he plans to add as much as 75 million barrels of oil to the nation’s Strategic Petroleum Reserve https://t.co/AtvqUynvS8
— Bloomberg (@business) April 20, 2020
In the midst of a pandemic, President Trump was able to convince Russia and Saudi Arabia to set their bickering aside and voluntarily cut oil production…
"Trump may have saved global financial markets, the U.S. energy industry — and the U.S. economy." https://t.co/iJVDJIF8wx
— Trump War Room – Text TRUMP to 88022 (@TrumpWarRoom) April 20, 2020
To conclude, the rebound will likely not be an exponential curve. Instead, the oil recovery should create a jaggered upwards staircase. In which, investors continually sell off their positions. Thus, if you are a short-medium term investor, your investment plan should factor in extreme volatility.
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The information above should not be taken as financial advice. Youth Investment Group has no liability for personal financial interests or investment decisions. You should make your own investment decisions based upon your own research and what you believe is best for you.
Written by Patrick McLoughlin, Senior Manager of YIG.