Why do oil companies pay so well

Invest in futures : As an investor, you benefit from the low oil price

Many investors have had their fingers tingling since April 20, as the sales of oil papers show. That day happened what hardly anyone had thought possible until then: the price of oil of the US variety Western Texas Intermediate (WTI), an important pacemaker in the oil markets, slipped into the red. Around 8 p.m. Central European Time, a barrel (159 liters) was at a low of minus $ 40.32, and in the end WTI oil closed at minus $ 37.63.

The commodity was already trading at plus $ 10 the next day, but quite a few investors had smelled blood. The coronavirus, which hit the world in a phase of global economic weakness, has dramatically depressed the price of oil overall: WTI oil is 77 percent in the red in 2020 so far. Brent oil has fallen a good 68 percent since the beginning of the year. Measured against the highs from October 2018, when Brent was quoted at a good 85 and WTI at just under 76 dollars per barrel, the minus is even 75 and 81 percent, respectively.

After the corona crisis will probably remain a temporary crisis and the global economy is slowly picking up again, quite a few investors are considering putting some money in oil. According to an old stock market adage, when the cannons are thundering, one should go on a shopping spree.

Oil deals are always limited in time

However, this is not so easy with oil. This has to do with the market and the way oil is traded. One secures oil almost exclusively through futures, i.e. fixed-term papers that guarantee a right to buy or sell at a certain date in the future. Whether oil companies, oil traders, companies or banks, investors, speculators: all of them buy or sell oil with the help of futures. Investors who want to bet on the price of oil with a certificate can also use it to buy futures indirectly.

April 20 showed what the worst-case scenario could happen when fixed-term securities with an obligation to buy or sell on a certain date hit a shaky market. Because the demand collapsed and the oil stores are full to the brim, there were no more buyers for the futures, which require purchase in May. Above all, large investors such as oil ETFs and speculators, who have to "roll" the investors' money into the next future every month, only found buyers in the end if they paid another 40 dollars as a bonus on each contract.

Computer-controlled trading systems and forced liquidations increased the problem massively. Experts call the problem with oil trading contango - the surcharge that market participants charge when they "roll" into the next future - and then have to pay a surcharge for storing the oil. April 20th brought a super contango to the market, which has in the meantime softened. Anyone who buys an oil paper now does not know whether the situation will relax or not until the next future change in May.

Much less oil consumption due to Corona

At the beginning of January, the earth needed just over 100 million barrels of 159 liters of crude oil every day to keep the economy running and the earth's population mobile. Since the coronavirus put billions of people and entire economies into a kind of artificial coma, the demand for the lubricant in the global economy has plummeted.

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The International Energy Agency estimates that demand fell by 29 million barrels a day, or almost a third, in April. Even a rapid global economic start-up would cap oil demand by an average of 9.3 million barrels per day. Some US banks are even assuming a drop in demand of currently 35 million barrels a day.

At the same time, production cuts are slow to start. The oil cartel OPEC and producing countries, above all the previous world market leader USA, will probably put a maximum of 12 million barrels less on the market each day in May and June than before. The cuts are expected to last two years. The consequences of a high supply with a dramatic collapse in demand are logical: the oil stores overflow, the price plummets.

How can a private investor buy oil?

Oil is tradable for private investors primarily through certificates or exchange traded commodities (ETC), i.e. passive investments in one type of oil. These are always bearer bonds, i.e. products that fictitiously depict the performance of oil and that are not protected against the bankruptcy of the issuing financial institution. Some products hedge this risk with gold or protect against currency fluctuations, because oil is always traded in dollars.

In order to alleviate the problem of future rolling, most providers have brought "roll-optimized" products onto the market: Rici Enhanced Brent Oil ETC from BNP Paribas or the xtrackers Brent Crude Oil Optimum Yield. Overall, says Commerzbank's raw materials expert Eugen Weinberg, the providers have adapted their products to the new challenges and no longer just roll into the next contract, but into a cheaper one. In addition, the rolling will be stretched in time.

The devil is in the details, however: Anyone who buys an ETC on oil at a Brent price of a good $ 21 and hopes for prices to rise could be disappointed. Not only because the price may stay in the basement for longer, but also because it is hardly involved in rising prices. Because the next time you roll, you may have to switch to a future that costs twice as much because of the very high storage costs. The investor would then continue to have the same number of certificates or ETC in the depot, but the investment would only be based on half the oil barrel.

If the price then rises, he would benefit significantly less from it. BNP Paribas, for example, reports succinctly for the WTI Oil ETC that the subscription ratio has changed from 0.70864587 to 0.43867726 as a result of the rolling into the July future. The opposite situation is also conceivable, but currently unlikely: future futures can also be cheaper than current ones. This is called backwardation and occurs, for example, when there is an oil shortage and the bearings are only moderately full.

Back to $ 40 a barrel by the end of the year?

Most oil analysts are currently not assuming that the situation on the oil markets will ease in the short term. On the one hand, demand will remain weaker in a recession triggered by the coronavirus, on the other hand it will take time until the high inventories are reduced again. So it could be years before the pre-crisis level is reached again. Commerzbank oil expert Eugen Weinberg nevertheless believes that Brent oil could at least rise again to $ 40 a barrel by the end of the year.

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Investors can also invest indirectly, through stocks that work in the oil business or benefit from cheap oil purchases. Those companies whose supertankers are currently used as floating oil storage facilities have done well recently. There are currently numerous giant tankers of the VLCC (Very Large Crude Carrier) class, each with around two million barrels of oil on board, off Singapore and the US west coast.

The charter rates have risen from 85,000 dollars per day to 220,000 dollars and more, depending on the rental period. Around ten percent of all around 750 supertankers plus thousands of other, smaller oil ships, which handle around 43 percent of the world's oil trade, are currently used as storage facilities. One of the beneficiaries is the Norwegian company Frontline, whose share has risen a good eleven percent in the past four weeks.

Oil multinationals are sitting on cash

Frontline owns 21 super tankers, plus almost 50 slightly smaller ships. If the mismatch between supply and demand continues, then analysts expect profits to quadruple. The Norwegian company Nordic American Tankers is also benefiting from the increasing freight rates. Since mid-March, the rate has tripled from EUR 2.3 to EUR 7.1.

The main customers of the freight companies are the large oil multinationals such as Royal Dutch Shell, BP or Exxon, who have booked the tankers for several months. If the demand for oil picks up again, the floating bearings for the transport would be missing, says Ashok Sharma of the ship broker BRS Baxi in Singapore. Then freight rates could continue to rise.

Some analysts are also optimistic about the prices of the oil multinationals themselves. It is true that everyone is currently having to cope with a massive drop in sales due to the low oil price. But the big oil companies are sitting on billions in cash, so that in many cases not even the dividends should be in danger, say Crédit Suisse and JP Morgan, for example. In addition, investments, costs and billion-dollar share buyback programs have been cut. Both recommend Total to buy, mainly because the group will be profitable at a relatively low oil price.

Is there even a threat of an oil shortage in 2021?

The bank also sees Chevron positively because the US oil multinational covers the entire value chain and is hardly in debt. At the moment, however, none of the large multinationals could generate positive cash flows with oil, according to Crédit Suisse. In the long term, the prospects are not bad: The fact that up to 60 percent of those US companies that extract oil at high costs via fracking could be threatened with bankruptcy could even lead to an oil shortage from 2021.

The analysts also see an incentive to buy in many oil stocks because the prices have already fallen massively. In mid-March, Chevron was trading almost 60 percent lower than last summer, but has since increased by 66 percent with the market. The picture is similar for most other multinationals. For companies from some other sectors, the low oil price could turn into a kind of special economic stimulus program. Chemical companies or large plastics producers, for example, who count oil among their most important raw materials, can save considerable costs with oil prices of around $ 20 per barrel.

Some providers also lure customers who cannot decide whether they should rather go into certificates or shares with a double construct. Depending on the contango situation, a strategy certificate from the Swiss Vontobel Bank invests either in oil futures or in oil and refinery stocks such as Chevron, Exxon, Valero or Halliburton. Currently there are only stocks in the portfolio.

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