Over the last month, we have seen the price of Crude oil benchmarks in the U.S. and Brent futures get destroyed. Both benchmarks lost right around two-thirds of their value during the first quarter and roughly 55% of their value during March alone.
The massive price destruction occurred because of many reasons. The first and foremost is the Coronavirus pandemic and how the world is fighting the spread of the virus. Shutting borders to foreign nationals, implementing 'Stay at home Orders,' and recommending 'social distancing' is all leading to a massive reduction in the demand for oil on a worldwide scale. Cruise ships aren't leaving ports, airlines have slashed their number of flights, both public busses and school busses are not operating, and the average person isn't driving their vehicles. We have already begun to see reports from around the world how pollution levels are declining due to these modes of transportation, essentially stopping.
The second reason the price of oil crumbled was because of the "price war' that is currently ragging between Russia and Saudi Arabia. The two countries were the main reasons the Organization of the Petroleum Exporting Countries (OPEC) couldn't agree on production cuts following the softening demand after the Coronavirus began spreading on a massive scale. Russia and OPEC's de facto leader, Saudi Arabia, disagreed on how much each country would reduce production in order to help stabilize the price of oil around the world.
The price war has caused the Saudi's to increase production from 9.7 million barrels a day in February to a targeted more than 12 million barrels a day in April. Thus far, they have held up their threats. As of early April, the first wave of crude was already heading toward Europe, and the U.S. Saudi Arabia hired extra supertankers in March. Those ships are positioned near oil terminals preparing to be filled.
This is all while oil sits around the $27 a barrel price point. Some believe it could fall further, down to $15 or even $10 a barrel, depending on how long the world economies are shut down due to the Coronavirus pandemic.
However, we could see the supply quickly get cut for several reasons. First, the Russians or Saudi's could realize this price war is hurting everyone more than it is helping anyone. They could agree to production cuts, and the price will stabilize. While I don't think that is going to happen in the short term, it is a possibility.
Another way supply could be cut is by the U.S. based Shale Operators. Most people in the industry consider $45 to $50 a barrel the break-even point for the shale production companies. At $20 a barrel, or even lower, these companies are losing money hand of fist ever single barrel they pull out of the ground. Their production, which the U.S. currently sits around 13 million barrels a day, could experience a quick and drastic reduction.
There have been reports indicating storage facilities in the U.S. are full, and that producers are actually 'paying,' not being paid, to just have their oil taken off their hands. U.S. production rates can't continue for long. Thus supply will be reduced over the coming weeks. The problem is, this supply reduction still may not be enough to pull the price of oil higher around the world due to the current economic situation.
This means we will likely have to wait for oil prices to climb higher in a meaningful fashion. Still, we will probably see higher prices at some point in the future simply due to a better supply-demand balance once the Coronavirus situation has passed.
So, despite it possibly taking weeks, months, or even a few years, buying oil today at their depressed prices could be a very profitable long-term investment. I would suggest buying Exchange Traded Funds that either own oil futures contracts or while it could take even longer for them to recover, you could buy the oil exploration and producers themselves. ETFs like the United States Oil Fund (USO) or the Invesco D.B. Oil Fund (DBO) will give you more exposure to the actual commodity of oil through the purchase of futures contracts. If you want to own the companies in the industry, buying shares of either the iShares U.S. Energy ETF (IYE) or the Energy Select Sector SPDR Fund (XLE) will give you that exposure.
While it should be noted that the price of oil or any commodity has a plethora of price influencing factors, it's hard to imagine in the long-term (i.e., years from now), the price of oil remaining at their current levels. With that being said, this is a 'riskier' investment, especially if you're investing in the commodity itself, so before making any purchases, please consider your own personal situation.
Disclosure: This contributor held Call Options on the United States Oil Fund (USO) at the time this blog post was published. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.