Thursday, April 23, 2020

The Oil Conun-Drum

By now, you may have heard of the news of crude oil prices plunging to the negative regions (minus 37.63 US dollars (USD) per barrel, from this news source) due to the drop for its demand in the current COVID-19 situation. 

Before assuming that free oil is around the corner (hurrah for vehicle owners), the crude oil market is not as simple as it looks. First, if you read carefully from the same news article, the negative price is for the West Texas Intermediate (WTI) May 2020 futures contract, which had just expired on Tuesday (21st April 2020). The WTI June 2020 futures contract as at the time of my writing was USD 14.57. Oil, being a commodity, is mainly traded through futures, which I had explained the mechanism of it in my ebook1. Because of oil’s low demand, very little buyers would want to take delivery on the batch of WTI crude oil associated with the May 2020 contract, and the producers would instead have to pay the buyers to get it from them, if any.

Second, there are many other crude oil types traded in the market, not just WTI. The other oft-traded crude oil is the Brent, which was at USD 20.58 as at the time of my writing, and it is extracted from the North Sea between the United Kingdom and Norway. There are many others, like Dubai Crude from Dubai, Bonny Light from Nigeria, etc., hence there is no universal crude oil price.

Third, even if a barrel of oil is at the negative price region, there are costs incurred in storing, refining and delivering before it reaches the end user, which brings the price back to the positive region (so no more hurrah for vehicle owners). On a side note, a lot of companies are involved in this whole process chain, and by sectoral association, most of their profit margins may be affected with the low oil price.

So Why Talk About Oil?

Crude oil is one of the three items that I had stated in the ebook2 for the commodities portion of the Bedokian Portfolio. Investing in oil is a bit tricky; Unlike the other two commodities, which are gold and silver, there is no convenient way of holding physical crude oil (unless you have a large tanker ship or own a regulated oil storage facility). Although investing in oil related companies is one common way, I would not recommend it as they are still companies at heart, i.e. equities, and profit margins, expenses, productivity, etc. varies across them, even if the price of oil is the same. Another way is to go the oil futures path, but if you are not familiar with this instrument then I suggest you steer clear from it.

There are exchange traded funds (ETFs) for crude oil, but unlike its commodity siblings gold and silver, which have the actual physical assets backing them, their holdings are consisted of oil futures. With this characteristic, the prices of oil ETFs do not really correspond the actual rate of increase or decrease on the item that they cover (e.g. the price of spot oil may have gone up by 10%, but the ETF price may be only up by 3%). This is due to the result of contango3, which is existent in futures market.

Having stated the above, plus the points on oil in my ebook, it is up to you on whether to add oil into your portfolio, especially now the price had hit rock bottom. If you are not familiar with futures and the dynamics of the “black gold”, then you could just remain with gold and silver as your commodities.

Disclaimer: The Bedokian is vested in United States Brent Oil Fund (BNO).

1 – The Bedokian Portfolio, p37-39

2 – ibid, p42-43

3 – Chen, James. Contango. Investopedia. 20 Apr 2020. (accessed 23 Apr 2020) 

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