What are the options?
The oil price has experienced major volatility in the first 5 months of 2020. The price is driven by supply and demand and with the global economic shutdown, supply has far exceeded demand resulting in a large pull back of the oil price. On the 20th of April of 2020, the near dated futures price of a barrel of West Texas Intermediate crude oil in the US reached negative $40 a barrel on account of this supply glut.
Brent Crude oil and West Texas Intermediate crude oil
Source: Bloomberg
While the above graph makes it seem as though gold only moves in one direction, the reality is that the gold price in rand terms will fall when the rand strengthens, or conditions normalise. The price of gold can move sideways for years while the market moves up. Gold should therefore be viewed more as a diversification tool when the underlying commodity has performed very well over a given period and the rand is weak.
20-year gold price in USD/oz. and the USD/ZAR exchange rate
Source: Bloomberg
Low oil prices have resulted in renewed interest in oil as an investment. We explore the different ways in which retail investors can gain exposure to oil prices.
Ways to gain investment exposure to oil prices
An important note on oil price ETN's
When investing in oil ETN's, investors will be exposed to "roll over risk". Futures contracts are purchased and "rolled over" when they expire. Near dated futures contracts are sold and further dated contracts are purchased. This could result in losses to investors when the oil market is in "contango". Then near dated contracts are sold at lower prices than at which further dated contracts are purchased. This difference is referred to as the "roll yield" and it may result in a substantial difference between actual oil price movements and the investor experience.
When deciding which underlying oil price to track, Brent crude oil price futures have the advantage of not being contracts for delivery which means the likelihood of big swings around roll over dates are less, particularly when the market is in contango.
Where do we think the oil price will go?
We anticipate oil prices will remain volatile near term as uncertainty around the depth of the demand shock following Covid-19 interventions and supply-side negotiations remain erratic. But there are several reasons to have a more constructive view longer term. These include an eventual recovery in demand, higher-cost production permanently leaving the market, and major oil producers coming to agreements on production cuts given that lower prices are bad for budgets of oil-producing countries.
Break even oil prices
Note: Fiscal break even for countries, profit break even for US producers Source: Bloomberg, IMF, BTU Analytics
