Tag: West Texas Intemediate

Who Is Most Endangered by Negative Oil?

Negative Oil

In a year filled with random and unexpected events, hopefully not likely to be repeated anytime soon, the price of oil going negative may stand out as a particularly unusual one. People are familiar with the idea of investments suffering losses and posting negative returns, but for an investment to be negative, to literally be worth less than zero is unique in our history.

All this, we may say, has been precipitated by an oil war being fought between Russia and Saudi Arabia, made worse by a pandemic that has slashed global demand by 30% and the cumulative effect of a global shift in oil production over the last decade that turned America into the world’s largest producer of oil. We may also assume that the worst hit in this mess are the oil producers themselves.

Oil Producers

Certainly in Canada it is easy to assume that it is Canadian producers most at risk from the collapse in oil prices, already suffering trying to get their oil to market more efficiently and cheaply than by train. But while the collapse in oil prices is indeed a headwind for producers, they are not the most at risk at being hurt by the volatility in oil’s spot price.

No, the one most at risk is you, the average investor.

It is important to remember that “financial services” are exactly that, retail products in the financial space. Products that you invest in may reflect a real need by investors, but they also reflect demand. As such it shouldn’t be surprising to discover that products exist that are not needed but are wanted. If someone thinks they can make money providing a vehicle of investment it will likely find its way to the market, for good or ill.

Exchange Traded Funds, the popular low-cost model of investing that has become very common, is where all kinds of investments like this appear. Reportedly there are something like 500 different ETFs in Canada alone. All this variety is good for the consumer, but maybe not for the citizen merely trying to save for their retirement.

Let’s turn our attention back to oil and to fate of investors that, having sensed that the price of oil was so low, they considered investing in the commodity was a “no lose” scenario. In the week before the price of West Texas Intermediate (WTI) went negative, investors put $1.6 billion into the United States Oil Fund LP (USO ETF). USO was one of a handful of investments that allows investors to try and invest in the actual commodity of oil and skip investing in an oil producing company.

Oil Price

What many of those investors likely didn’t realize is that to get close to the price of oil you have to buy oil contracts that expire very soon. USO did this by holding contracts that mature within the month and then roll those contracts to new contracts for the following month, and so on. This keeps USO’s price and performance close to the spot price (the price the oil is trading for at that moment). But it also means that USO must sell those contracts it holds onto other buyers every month or it risks having to take physical delivery of the oil it holds the contracts for.

The problem should become self-evident. As the May month end contract was approaching, and with oil prices low and storage at a minimum, oil buyers didn’t want USO’s contracts, and USO couldn’t physically receive the shipment of the oil. It had to get rid of the contracts at any price, and that’s just what they did, paying buyers to take the oil contracts off their hands.

ETFs, Mutual Funds and a host of other investments make it seem as though investing has few barriers, with ease of access making experts of us all. But that isn’t the case. The unique qualities of a product, the mechanics of how some investments work and ignorance about the history of a market sector can spell danger for novice investors that assume markets are simple. In Canada there are only a few investments that deal directly in the commodity of oil; the Auspice Canadian Crude Oil ETF (due to be closed May 22 of this year), the Horizon BetaPro Crude Oil Daily Bear and Daily Bull ETFs (HOD and HOU respectively, both of which may have to liquidate. Horizon ETFs have advised investors NOT TO BUY THEIR OWN ETFS!) and lastly the Horizon’s Crude Oil ETF, which uses a single winter contract to reduce risk but will radically alter the performance compared to the spot price.

Many investments are not what they seem, maintaining a superficial exterior of simplicity that masks the realities of a sector or structure that can be a great deal riskier than an investor expects. In 2018 investors that had purchased ETFs that traded the inverse of the VIX (a “fear gage” that tracks investors sentiment about the market) suffered huge losses when the Dow Jones had its (then) largest one day drop ever, wiping out 80% of the value of some of these investments. Then, like now, investors had a poor understanding of what they owned and were easily blindsided by events they considered unlikely.

As I’m writing this I see reports out that suggest the price of oil could once again go negative. Whether they do or not is irrelevant. It is enough to know that they can and that investors will have little defence against a poorly constructed product that has the ability to go to zero. Before last week the USO ETF owned 25% of the outstanding volume of May’s WTI contracts. That was a concentration of risk that its investors just didn’t realize or understand. Today its clear just how dangerous that investment was. Investors owe it to themselves to get some real advice on what they invest in, and make sure those investments fit into their risk profile and investment goals.

Information in this commentary is for informational purposes only and not meant to be personalized investment advice. The content has been prepared by Adrian Walker from sources believed to be accurate. The opinions expressed are of the author and do not necessarily represent those of ACPI.

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

The Media is Turning Market Panic up to 11 – Learn to Tune Them Out

The current market correction is about as fun as a toothache. Made up of a perfect storm of negative sentiment, a slowing global economy and concerns about the end of Quantitative Easing in the US have led to a broad sell-off of global markets, pretty much wiping out most of their gains year-to-date.

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This is what my screen looked like yesterday (October 15th, 2014). The little 52L that you see to the left of many stock symbols means that the price had hit a 52 week low. The broad nature of the sell off, and indiscriminate selling of every company, regardless of how sound their fundamentals tells us more about market panic than it does about the companies sold.

One of the focal points of this correction has been the price of oil, which is off nearly 25% from its high in June. Oil is central to the S&P/TSX, making up nearly 30% of the index. Along with commodities, energy prices are dependent on the expectation of future demand and assumed levels of supply. As investor sentiment have come to expect that the global demand will drop off in the coming year the price of oil has taken a tumble in the last few weeks. Combined with the rise of US energy output, also known as the Shale Energy Revolution, or fracking, the world is now awash in cheap (and getting cheaper oil).

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The price of Brent Crude oil – From NASDAQ

But as investors look to make sense out of what is going on in the markets they would be forgiven if all they learned from the papers, news and internet sites was a barrage of fear and negativity masquerading as insight and knowledge. The presumed benefit of having so much access to news would be useful and clear insight that could help direct investors on how to best manage the current correction. Instead the media has only thrown fuel on the fire, fanning the flames with panic and fear.

WTI & BrentContrast two similar articles about the winners and losers of a dropping price of oil. The lead article for the October 15th Globe and Mail’s Business section was “Forty Day Freefall”, which went to great lengths to highlight one big issue and then cloak it in doom. The article’s primary focus is the price war that is developing between OPEC nations and North American producers. Even as global demand is reportedly slowing Saudi Arabia is increasing production, with no other OPEC nations seemingly interested in slowing the price drop or unilaterally cutting production. The reason for this action is presumably to stem the growth of oil sand and shale projects, forcing them into an unprofitable position.

 

This naturally raises concerns for energy production in Canada, but it is not nearly the whole story. The Financial Times had a similar focus on what a changing oil price might mean to nations, and its take is decidedly different. For instance, while oil producing nations may not like the new modest price for oil, cheap oil translates into an enormous boon for the global economy, working out to over $600 billion a year in stimulus. In the United States an average household will spend $2900 on gas. Brent oil priced at $80 turns into a $600 a year tax rebate for households. Cheaper oil is also hugely beneficial to the manufacturing sector, helping redirect money that would have been part of the running costs and turning them into potential economic expansion. It’s useful as well to Emerging Economies, many of which will be find themselves more competitive as costs of production drop on the back of reduced energy prices.

A current map of shale projects, and expected shale opportunities within the United States and Canada.
A current map of shale projects, and expected shale opportunities within the United States and Canada.

Business Reporting isn’t about business, it’s about advertising revenues.

While Canada may have to take it on the chin for a while because of our market’s heavy reliance on the energy sector, weakening oil prices also tends to mean a weakening dollar, both of which are welcomed by Canadian manufacturers. Corrections and changing markets may expose weaknesses in economies, but it should also uncover new opportunities. How we report these events does much to help investors either take advantage of market corrections, or become victims of it. As we wrote back in 2013, business reporting isn’t about business, it’s about advertising revenues. Pushing bad news sells papers and grabs attention, but denies investors guidance they need.

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc