Oil Prices and How it Affects the Nigerian Investor

At the start of the year, West Texas Intermediate (WTI) — used as a benchmark in oil pricing — sold for up to $60 per barrel. But the shortfall in demand and other conditions has sent prices tumbling, reaching negative territory in April.

Some oil producers were forced to pay buyers for the oil they pump as prices slid below $0 a barrel to $-38 as of Monday, April 20, 2020.

The United States Energy Information Administration (EIA) in its recently released Short-term Energy Outlook outlined lower economic growth, less air travel, and lower oil consumption around the world as major drivers of this trend. The EIA also noted that the dip in global oil demand in 2020, while supply remains at the current level, could lead to a global oil inventory build-up that is “twice as large as the largest annual inventory build (1.8 million b/d in 1998)” in the history of the IEA.

As at 21st April 1998, WTI traded at a low of $15.45 per barrel caused by a supply/demand imbalance. After only 2 years, the price had risen more than 100% after oil-producing countries agreed to supply cuts.

On the Daily Market Watch, we examined the oil situation and how traders and investors can take advantage of the short term imbalance in the oil market.

What is happening in the oil market from a layman’s perspective?

This is a classic case of broken supply and demand. If you have shortage in the supply chain for an in-demand commodity, prices can skyrocket. On the other hand if you have a surplus when demand is falling, prices crash.

Prices were negative because the storage space for WTI was full so buyers had to take on delivery. To avoid taking on delivery, they were willing to sell at a negative amount — literally paying someone to take the oil off them. Also, there’s not enough demand to clear out storage at the moment. The shortage of demand is of course caused by the lockdowns and reduced economic activities — both are caused by the coronavirus pandemic and the fear of the virus.

Though the price of oil being at such low levels benefits the ultimate consumers of oil, there’s the worry that if this lasts for a long time, there could be inflationary consequences. There could be a knock-on effect that would be bad for the Nigerian economy — low government revenues and

From an investor’s point of view, is it advisable for an investor to get exposure to oil since prices are low right now?

If you’re looking at taking an opportunity in the oil market right now, you have to ask yourself if you’re a short term trader looking to capitalize on the price dislocation or a long term investor in oil thinking that the fundamentals are ultimately in your favour. Remember you have to factor in the cost of holding oil, your investment time frame and analyze whether it makes sense for your goals.

For most people, investing or trading in oil is exotic. The main perspective we’ve explored through this time has been to seek exposure by triaging the worst risks and focusing on those most likely to survive or thrive:

• The companies and sectors are getting stronger in this lockdown
• The companies and sectors are going to bounce back quickly
• The biggest players in industries that may be affected now, but are likely to be consolidators not the consolidated.

If you are looking for opportunities during this oil crisis, there are better and more straightforward plays to make than an exotic oil trade.

However, if you believe that there’s some opportunity or insight you have in the oil market, you could add some exposure to oil and other commodities in your portfolio. Moreover, adding oil exposure to your portfolio could be another way of diversifying away from all of the other traditional assets like bonds and equities. If you think that the return profile is very good for oil right now, you could add a small allocation to your portfolio.

You can use the United States Oil Fund (USO) to buy into WTI and the United States Brent Oil Fund LP (BNO) to buy into Brent. This represents a good system for buying directly into oil although the synthetic derivative methodology applied by these funds means there could be some tracking error. Investors can also target Energy stocks or Energy Sector Stock ETF (VDE) as an indirect and easy way to gain exposure.

From a trader’s point of view, is it an attractive time?

The question to ask is how much lower can oil go? Demand and supply is currently broken, majorly from the shock from the coronavirus pandemic.

If you are looking to make an oil trade, it is potentially attractive because of the asymmetric opportunity — how much lower can it go versus how much higher can it go? While this return profile can attract traders, the time-frame for a satisfying payout is very dependent on the length of time it takes economies around the world to restart and how long it takes the oil market to consume excess capacity and return to a more balanced level.

Tune into Chaka’s webinars to get live takes on the global and local markets from a Nigerian perspective at www.chaka.ng/webinar