The global oil downtrend seen in April 2020 was unprecedented. Several records were shattered, including all-time price lows, with some contracts actually going into the negative. The catastrophe in oil markets was caused due to various factors, the most prominent of which is the coronavirus pandemic, which brought demand to a near standstill. However, as is often the case during such bearish trends, some traders and investors see this as an opportunity, rather than a crisis.
The Backdrop to the Crisis
During the first quarter of 2020, oil was impacted by two major factors. The first was the coronavirus pandemic, which led to the shutdown of numerous factories, the cancellation of flights, billions around the world living under lockdown and many other causes that shrunk oil demand. The second factor was a price war between two of the world’s largest oil producers, Saudi Arabia and Russia, which ended when the sides agreed to a historic production cut of nearly 10 million barrels per day.
These two factors combined led to an unprecedented bearish trend in the oil market, eventually pushing prices so low that some contracts even turned negative. With double-digit price swings seen day after day, and prices going down, then recovering, and then falling again, many traders tried to take advantage of the situation and generate short-term profits. At the same time, some investors, confident that the market would eventually recover, considered this a chance to buy oil at a discount.
The Geopolitical Balance of Power
Oil is a great source of power in the world, both literally and figuratively. Since a significant part of the world’s energy comes from oil, those countries which produce it, hold a certain amount of political power. However, once demand came to a standstill and reservoirs started overflowing, the leverage these countries had was greatly diminished.
Moreover, many of these oil producers are financially dependent on oil. Countries such as Canada, Iran, Russia, Saudi Arabia, the UAE, and the US all generate a large part of their GDPs from black gold. While some countries have other sources of income, others are almost completely dependent on oil, putting them in dire straits when markets around the world crashed.
How did Prices turn Negative?
While it sounds pretty straightforward, the process of buying and selling oil on the market is not that simple. There are numerous futures contracts, ETFs and other derivatives that impact and are impacted by the price of various oil types. For example, some contracts try to predict the price of oil next month, while others have longer expiry dates. Some ETFs combine several futures contracts together and/or add energy companies’ stocks into the mix. eToro offers a wide variety of these products, including spot oil, ready-made portfolios, ETFs, futures and more.
The futures contract is one of the reasons that oil prices turned negative. Many of those who buy such contracts don’t actually intend to own the barrels delivered when the contract expires. They simply sell it before it expires with the hope of turning a profit. However, when there were absolutely no buyers, and these contract owners feared oil barrels would be delivered to them, they went as far as offering people money to take the contracts off their hands, resulting in negative prices.
A similar phenomenon was seen in the oil production industry, as some producers who reached maximum storage capacity, were willing to pay clients to take the excess oil off their hands.
Where is Oil Heading Next?
The short answer is “nobody knows.” On the one hand, the coronavirus’ impact on industries such as travel is far from over, and it might be a long time before global oil demand recovers to its pre-coronavirus levels. On the other, while renewable energy is becoming increasingly widespread, it is still far from being able to support all of the world’s energy needs, meaning that demand for oil is here to stay.
Furthermore, superpowers such as the US and Russia, which need oil prices to recover to maintain their GDPs, may intervene to ensure the survival of the industry. At the same time, oil corporations may see this as an opportunity for mergers and acquisitions, thereby, restructuring the oil industry.
Investing in the Oil Market
As mentioned above, the current situation can be seen both as a crisis or as an opportunity. For those who consider this an opportunity to get into the oil market, eToro has created the OilWorldWide Smart Portfolio. This managed investment strategy gives investors diversified exposure to both prominent oil companies and select oil derivatives. The portfolio is available on eToro and investors may already add it to their Watchlists.
Some believe that the oil market will never be the same, and they may be right. However, as the coronavirus pandemic becomes more manageable, and powers in the oil market consolidate, it is possible that this market will emerge stronger.
Copy trading and Smart Portfolios is an investment management service provided by eToro Europe Ltd., which is authorised and regulated by the Cyprus Securities and Exchange Commission.
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 62% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.