In the last 12 years, the oil market has thrice collapsed and twice recovered. But this latest downturn, driven by a covid-tainted drop in demand and a Russo-Saudi price war, has analysts scratching their heads. Can the market rebound from this?
The price of US oil turned negative for the first time in history last month, meaning producers were paying buyers to take the commodity off their hands over storage capacity fears. Millions of dollars were made and lost by traders riding the disruption.
It’s clear that covid represents a landmark moment for oil. The industry was already in a period of climate introspection, dampening demand and investor scepticism over the long-term viability of fossil fuels.
For those trading oil futures and options, the rules of the game have changed. But that isn’t to say there aren’t opportunities to be had. Oil and gas will remain a multi-trillion-dollar market for decades. It is too important to fail and we are all reliant on it, whether we like it or not. Demand will return as normality does: it hasn’t gone anyway, it’s just in hibernation.
In the short term, populations are adapting to this ‘new normal’. There will be more people driving cars, for example, than taking public transport, possibly increasing consumer demand.
Longer term is harder to forecast. McKinsey analysts predict that the industry ‘might even benefit from a modest temporary price spike, as today’s massive decline in investment results in tomorrow’s spot shortages’.
A permanent change in pricing is harder still to estimate. There are no crystal balls. No one saw the pandemic coming – calling what will happen next is essentially impossible. One thing is clear, though: this disruption may continue for some time.
Last month’s market tension created huge differentials in oil expiries, as would be expected of any crisis. There’s nothing to say that couldn’t happen again. Yet on Monday there were already glimmers of hope. When the June contract expired, trading was smooth, signalling that the fundamentals with supply, demand, and storage availability have improved since last month.
Analysts predict that “in most best-case scenarios, oil prices could recover in 2021 or 2022 to pre-crisis levels of $50/bbl to $60/bbl”. This is a level that would balance production costs with a sensible price that justified continued investment in the sector.
But balancing supply and storage issues with underlying demand and the inevitable geopolitics common in oil trading requires both a strategy and a platform that can accommodate it. Overall, futures markets involve a substantial amount of speculation. When contracts are further away from expiration, they are more speculative but more fruitful when they pay off. There are a few reasons for an investor to lock in a higher futures price, and this covid contango represents one of them.
One of the attractions of a futures contract is that until the delivery date, the buyer does not possess the commodity and does not have to worry about its storage. With the cost of crude far below what the market is expected to pay in six months’ time, a trader can buy crude now and sell it forward, in effect locking in the price difference between the dates. Provided the contango is wide enough to cover the cost of storage, finance and insurance, it will be profitable.
Mini futures are a particularly flexible way for traders of all sizes to enter the futures market. These open-ended securities do not have a predefined expiration date, which means they have no time value and makes valuation simple. With Fineco, mini-futures can be traded efferently and with a fixed, low price point for each trade.
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