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investing in oil

Written by Peter Siks | 5 minutes
MON 04-05-2020
Looking at the chart of the oil prices (Crude Oil Futures, the June contract), you will see that the drop is extreme. This has multiple reasons: first of all, there was a period there was a downturn in economic activity, which will have a negative effect on the price of oil. This can be seen from the beginning of January. In the second place, there was a conflict between the oil-producing countries. Ultimately, ‘solved’ in reducing production, but the structural effects have yet to be revealed. Besides, the impact of the coronavirus, resulted that the demand for oil reduced further, and the image appears to be complete.
 Graphic of the June Contract (Source: CME)

The May contract- Negative 
But it can get worse. The oil futures are physically settled. In other words: the oil is really delivered. And that part went wrong because the storage tanks were full. Traders did not want to have the oil physically delivered because they could not store. The price fell and even turned negative. The May contract (which expires in the month before and here was April 21) has been trading at a negative price of - $ 40. This has never happened and does indicate that there are exceptional circumstances. 

It can be seen here in the graph:

Later delivery months 
However, if we look at the prices of the futures for later delivery months, they are (significantly) higher than the current spot price. The market is now anticipating the oil price will improve in the future. This effect is also called 'Contango', which means that the more distant contracts become more expensive - related to the spot price - when the term is longer. This is an annoying effect if you have a long position in an oil future (or a product based on an oil future). If the oil price stabilizes at the current level, you will have lost the premium paid in the future (the contango effect).
This effect is visible in the prices of the various expiry months on the oil future market.

The graph below shows the prices of several expiry months.

The red line is the delivery for May, the green is the June contract, the light blue is the September contract and the yellow is the December contract. The prices are on the right axis. The contango effect is clearly visible.

The value of your investments can fluctuate. Past performance don’t guarantee future performances.

Higher or lower?
The oil price depends on supply and demand. On the supply side, there is more than enough at the moment (even after the production limitation). The demand for oil is, of course, related to the economic impact of the global measures being taken to curb the Corona virus. If these virus keep the economy locked  for a long (er) time, the impact can be very significant. At the same time, this will lead to the bankruptcy of a number of US shale oil producers. This will be unfortunate for the companies ,however this would help restore the balance between supply and demand. So there is currently little to say about the actual impact of the global lockdown on the economy. And so about the oil price. But what are the options for you as an investor to invest in oil?

Individual Stocks
Of course, you can choose to invest in individual stocks of companies associated with oil. The most famous is Royal Dutch Shell. The most important oil shares for Binck customers are shown here:


You can also think of oil related companies such as Fugro, SBM Offshore or the American Schlumberger. If you believe there is an upside potential in the oil price,  then these stocks are likely to benefit.

Oil ETF’s 
A different way, in order to be able to take an advantage of an expected increase in the price of oil is due to the purchase of a basket of shares of firms that are all oil related. For the European market think of:  Lyxor  ETF STOXX Europe 600 Oil and Gas of iShares STOXX 600 Oil &Gas UCITS ETF DE. If you want to focus on the worldwide energymarket, you may want to look into: The SPDR MSCI World Energy UCITS ETF


The oil-price itself
The most direct way to respond to a movement in the oil price is to take a position in oil. Because you cannot trade in physical oil yourself, you could use an ETP (Exchange Traded Product) based on the oil price, or a future.

An example of an ETP, is from Wisdomtree, which follows the price of Brent  (the bottom of the table above). But be warned, this product is able to face the discussed contango effect.

Then there is also the future on oil. Pay attention! Before investing in oil futures, read the information regarding investing in futures. We recommend that you only invest with futures if you are an experienced investor and are aware of the operation and risks. The results can be very significant, especially in such volatile circumstances.

Visit the product page on the CME where you can find everything about the contractspecificaties, such as settlement systems, trading-times and contract size. And, once again, the oil futures markets may only be suitable for experienced traders.

An underlying value that moves significant is inspiring the imagination of an active investors that likes movements. It should be noted that the oil market is at this moment in time, through its most tumultuous period ever. To act in a negative oil price ( in 1 specific future) is one of the most extreme example of this. The question that you should ask yourself is : is this aligned with me, and do I want to do this? If you have a positive response, you have already been provided with some possibilities. 


Peter Siks

With more than 30 years of experience, Peter Siks has now been tried and tested in investing. Among other things, Peter is interested in the psychological aspects of investing and since 2010 he has been working at BinckBank as an investor trainer.

The information in this article should not be interpreted as individual investment advice.  Although BinckBank compiles and maintains these pages from reliable sources, BinckBank cannot guarantee that the information is accurate, complete and up-to-date. Any information used from this article without prior verification or advice, is at your own risk.  We advise that you only invest in products that fit your knowledge and experience and do not invest in financial instruments where you do not understand the risks.

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