[ad_1]
Oil lives one of the worst years in memory. And yesterday lived a historic day reaching negative trade values for the first time. In just four months, the price of a barrel of WTI (West Texas Intermediate) oil, the type of oil used as a benchmark on the New York Stock Exchange, fell from $ 65 to $ 40 negative. (In Portugal, the reference for the price of fuel is the Brent barrel, and not the WTI, but we will go there).
That’s right, the barrel of oil reached a territory never explored before, reaching values below zero. Basically, producers paid buyers to get rid of the oil that they will not be able to remove.
But let’s go by parts: what is the reason for the devaluation of oil throughout this year?
– Decrease in demand.: Due to the spread of covid-19, the world economy stopped and with it the demand for oil fell dramatically, responsible for 37% of world energy production. According to the monthly report by the International Energy Agency (IEA), published on April 15, it is estimated that oil demand will continue to decrease by approximately a third in April, to minimum values close to the values of 1995
– Increased supply: When Saudi Arabia, the “leader” of OPEC and the most influential member, decided at its last meeting in Vienna to break its recent strategic oil partnership with Russia (and increase oil production in April while significantly reducing the price it charges its customers), oil prices saw their biggest drop since the Gulf War in 1991
This “oil war” was not well received by most oil-exporting countries, international energy companies, and US producers of shale oil, as the collapse in prices will dramatically decrease their incomes and, in many In some cases, it will force the bankruptcy of some companies in the sector with extraction costs higher than the price negotiated in the market.
Thus, with Donald Trump as moderator, Saudi Arabia and Russia returned to the “negotiating table” and OPEC + (Organization of Petroleum Exporting Countries and allies) ended on April 12 sealing a historic agreement to reduce oil production. 9.7 million barrels per day from next month, which represents around 10% of the world supply. But despite being the largest concerted cut in history, that reduction is not deep enough to cope with the short-term decline in oil demand.
The decrease in consumption is causing the accumulation of oil stored on ships (currently using 70% of its total storage capacity), as producers are trying to save the extracted oil to sell it in the future at a better price. , when demand increases again. The problem is that, at the rate at which they store the oil, they will only last a few more weeks until they reach their capacity limit.
With global blockages dramatically reducing oil demand, the lack of space to store would further affect already depressed prices in the short term, leaving producers with few financial or physical alternatives, forcing them to turn off the taps.
What happened
The drop in oil prices to negative levels was due in part to the way oil is traded.
When investors intend to trade oil, they do so through futures contracts. These contracts oblige the investor who buys the contract to buy barrels of oil at a future date, at the price currently negotiated, unless the investor sells his contract before the delivery date.
A futures contract corresponds to 1,000 barrels of crude oil, delivered to Cushing (it’s a city in Oklahoma that serves as the center of the West Texas intermediate oil trade), where energy companies have storage tanks with approximately 76 million barrels capacity. . And if the investor really wants to receive the barrels of oil personally, he can do so, since he only has to organize the delivery of them to his broker (that is, the intermediary through which he exchanged the oil).
For example, if an investor buys an oil contract (corresponding to 1,000 barrels) for $ 20, and the end (expiration) of that contract is in July, this means that upon expiration of the contract, that investor will have to buy 1,000 barrels at 20 dollars each, that is, you will invest 20 thousand dollars, regardless of the price at which the price of oil is negotiated at that time.
Each contract is negotiated for one month, and the contract expires in May 2020 today (Tuesday April 21, 2020). What happened was that the investors who had the May contracts did not want to receive the oil and incur storage costs, and in the end they had to pay people (read investors in the financial markets) to take it away from them. hands. hands
The June contract, with delivery within a month, is still trading around $ 11 a barrel (as of this writing), but yesterday’s drop in prices indicates that most of the storage space ceased to exist.
Therefore, it will be a matter of time before OPEC + countries come together again to further reduce current oil production, so that there is a balance between supply and demand. And to guarantee, above all, that the price of a barrel can recover to $ 40 per barrel, a value that many producers can already benefit from.
In addition to expecting a decrease in supply in the coming months, with the economic recovery will come an increase in demand, which, in turn, will eventually cause an increase in the price of oil.
In short, even if demand increases in the long term to pre-pandemic levels, it will take a few months to consume all the stored oil, which could lead to more days of panic than we experienced yesterday. However, it will only be a matter of time before the price of oil rises again.
Can oil be invested in a long-term perspective?
The problem is that investing in the rise or fall of oil prices is not an easy task. Due to the nature of futures contract negotiations, there is no continuous oil instrument on which the investor can bet, depending on the rise (or not) of prices.
There are so-called ETFs (exchange-traded funds), which are investment funds traded on the stock exchange as if they were shares and whose purpose is to replicate a certain asset, which can be an index, a certain sector of activity, a raw material , among other assets. The problem with ETFs that replicate oil is that, to replicate the behavior of their underlying asset, they have to do it through futures contracts, which eventually suffer the same evil as retail investors: roll performance.
A roll performance It is the benefit / cost that can be generated by investing in the futures market due to the price difference between futures contracts with different expiration dates. Since most futures investors do not want to receive the physical asset that the futures contract represents, they make the call overturnThat is, they sell the futures contracts that will expire in the short term, at the same time that they buy the futures contracts with later expiration dates. By doing so, the investor maintains his investment in the asset without having to receive physical deliveries, that is, he does not need to receive barrels of oil at home.
When the prices of futures contracts with more distant maturities are negotiated at prices lower than those negotiated for the contract with the most recent expiration, it means that the investor will be able to maintain the investment in the asset at prices lower than what it had: call Backwardation. Currently, we live in the opposite situation: the call Contango. In other words, future contracts with subsequent maturities are negotiated at prices. much higher contract prices with most recent expiration. This means that in order for an investor to maintain their investment in crude oil, when the time comes to overturn you will have to buy barrels of oil at a much higher price than the price that the expiring contract sells, roll performance negative and does not benefit from price increases.
We are currently experiencing a “Super Contango” phase, where the difference between the price of the most recent future contract and contracts with later maturities reached this week the largest difference since February 12, 2009. The difference between the contract maturing in June and the contract for the following month exceeds $ 9, that is, the investor, if he wants to continue investing in oil, will have to pay another $ 9 per barrel.
This “Super Contango” period is a reflection of market expectations that the current oil supply will be resolved in the future and that prices in the medium term will increase again. However, in the short term, the imbalance is so great that oil storage in the US USA It could be depleted, putting further pressure on oil prices in the short term.
What are the alternatives for those who want to invest?
The first may involve the purchase of shares in companies in the oil sector that have a high correlation with the price of a barrel of oil. However, it is important to know which companies you will choose for your investment portfolio, as many are at serious risk of bankruptcy or capital requirements.
The second may involve the purchase of futures contracts with more distant maturities. However, the price to pay, as we have already seen, will be much higher than what is being negotiated in contracts with more recent maturities.
Neither of these alternatives is perfect, but it definitely exceeds the cost of roll performance I already explained it previously.
This is undoubtedly one of the craziest and most atypical periods in the oil sector, both due to the prices reached and the price differential in the futures market.
If oil is “below zero”, will diesel and gasoline be “free”?
Many people, and rightly so, question the difference in the evolution of oil prices in financial exchanges and the price of diesel and gasoline.
The oil that serves as a reference for the Portuguese pockets is the Brent of the North Sea, a type of oil used as a reference in the London Stock Exchange, which has devalued more than 70% in recent months (but, still, not so much such as oil listed on the New York Stock Exchange, the aforementioned WTI).
First, it is important to mention that the oil traded on the stock market corresponds to crude oil, that is, crude oil. However, fuel prices come from the prices of petroleum products, such as gasoline and diesel, which do not immediately follow the evolution of the price of crude oil. Although related, the markets in which they are traded are independent, meaning that the impact of the short-listed value of a barrel of oil on the stock exchange can only be seen in the long term. This is due to various factors, from seasonality of consumption, to weather conditions and availability of refineries. Furthermore, the cost of transforming oil into fuels increases the price of the raw material in question.
Secondly, it is always important to keep in mind that more than 60% of the participation in the average retail price of fuels in Portugal corresponds to taxes, that is, a large part of the amount charged per liter of fuel that is found in bombs scattered across the country. It is made up of taxes, so the change in the price of a barrel of crude oil will only have an impact corresponding to its weight in the price.
Third, we can assume that the “delay” in updating fuel prices corresponds to the margins that companies in the sector benefit, regardless of the trend in fuel prices.
Therefore, we will continue to see a drop in the prices of gasoline and diesel until May, but we will not see that fuel is offered or that there will be incredible falls as we see today in oil.
Bruno Janeiro is a trader, financial analyst and co-founder of Air Trading.
