What Goes Up Must Come...Negative?
April 20, 2020
In my last article, "Death of Oil", I wrote:
"Last week, however, Trump announced that he was talking to the Saudis and Russians about a big cut to production. Oil and oil-related stocks jumped immediately, a bit overexuberantly in my view. If we have excess supply of 20 million barrels per day and OPEC+ agree to cut production 10 million barrels/day, it just takes a little bit longer to fill storage globally. Once filled, what is the value of any new produced oil if there’s no place to put it?"
Fast forward two weeks. OPEC+ did agree to cut around 10 million barrels/day starting next month. The market quickly digested the news and realized that it wasn't enough to prevent supply from filling. As for the "value of any new produced oil if there's no place to put it," we were given a pretty big hint today about what it would be worth.
Check out the chart below. The May oil futures contract closed today at MINUS $38.39. Yes...minus, negative, less than zero. That's DOWN $56.66 for the day. Typically, when I see a chart like this, I'm pretty sure there's some bad data involved, but not this time. A negative oil price essentially means that oil companies will pay you to take their oil. The only practical reason they would do so is if there's no demand for the oil, meaning that there's no way to get the oil from their wells and into storage. I'm oversimplifying here as different types of oil from different geographies all have different prices, but the point is still valid. This is a huge wake-up call to the world that storage is filling rapidly.
I doubt many people will get beyond the headlines screaming about negative oil prices, but it helps to understand what's really happening if you're looking for investment opportunities. For starters, as ugly as the oil market is these days, it isn't really -$38 ugly. What gets lost in the dramatic headlines is the fact that this action took place in the May futures contract, which expires tomorrow. Most oil traders have already moved on to the June oil futures contract (see table below), which more accurately represents the spot (current) oil price of POSITIVE $21. When we wake up Wednesday, the May contract will be gone, and the current oil price as represented by the June contract. You may see some ridiculous headlines about oil rising from -$38 to $20 in one day, and I'm sure the heads of a few novice investors will explode, but oil didn't really fall to -$38 today, and it isn't rising $50+ on Wednesday.
It's important to understand why today's dramatic drop to negative prices is misleading. It's just as important to note that the much more relevant June contract fell 16% today to a new low. Clearly, supply is grossly outstripping demand currently, and supply is filling up quickly. If this situation holds over the next month, we should see more pressure on prices in the near term, and we'll likely see the June contract head lower. In addition, there are large ETFs involved in this space (like USO) that are exacerbating price moves.
I haven't forgotten that I wrote only two weeks ago that I eventually expect oil to hit $100/barrel again. I don't expect that in 2020, but I do expect it in the next few years. This isn't because of the OPEC+ production cut, and it definitely isn't on the hopes that Trump follows through on his rumored plan to pay U.S. producers to not pump their oil out of the ground. That's right. We're actually talking about paying oil companies to not work. Econ 101 is going to fix this market in time. Many producers are losing money hand-over-fist and have already started to shut-in (curtail) productions. Many of the shale plays I highlighted will be going out of business. The Saudis and Russians need higher oil prices for their budgets to work. Today's terrible oil market is setting the stage for an explosive oil bull market in the years ahead.
The other relevant point to take from the chart above is that contango has widened again, as we expected. As a reminder, this is the difference between the price of oil today (spot) and the price of oil to be delivered at a later date. For example, you can see in the table above that June oil is being priced at $21 while December oil is trading for nearly $33. If you're able to store oil, you can buy oil today for $21 and sell it (today) for December delivery and pocket $11 for each barrel. You'll need to arrange and pay for 6-months of storage, but $11/barrel give you a lot of room to pay for storage. Speaking of storage...this widening contango and today's dramatic message of dwindling storage has once again sparked interest in our tanker stocks. We're going to see more of these tankers being used to store oil, and I expect investors and Wall Street will be shocked by the cash flow these companies generate in the coming quarters. This is the primary way we're positioned to benefit from the current oil market.
Our other large energy bet is uranium, and the recent mining supply cuts there have finally shaken the industry out of a long slumber. The next chart is from tradingeconomics.com, and it shows that the price of uranium has jumped from $24 to $32 in just the last month. I don't expect this pace of increase to continue unabated, but this undersupplied market is eventually going to need prices well in excess of $50 to encourage the development of adequate new uranium supplies in the years ahead. We've seen a big jump in the uranium stocks with this recent price move. Fortunately, we took advantage of the March fire sale to build out our full positions. Hopefully, this is the first leg higher of the multi-year uranium bull market I'm expecting.
Between uranium and the tankers, we have a pretty sizeable exposure to energy currently. Nevertheless, these aren't the only compelling energy plays I'm finding. Oil producers and energy service stocks with decent balance sheets capable of surviving the current devastation will eventually be big winners. In addition, natural gas stocks have a nice tailwind as about 40% of natural gas come from the production of shale oil wells. As these wells are shut-in, we'll see the supply of natural gas start to decline. I'm sensitive about having too much exposure to one sector, so hopefully we'll be able to roll out of our tankers and into some of these other plays opportunistically in the weeks and months ahead.
Ken Bell, CFA, CFP, MBA, Contagoist
Aspera Financial, LLC
The Market Rubbernecker is associated with Aspera Financial, LLC, an investment management and financial planning firm based in the Cary, Raleigh, and Durham area of North Carolina. This and all Market Rubbernecker missives and musings (written, oral, or mimed) are subject to the disclaimers, disavowals, and hindquarter-coverings found at www.asperafinancial.com/aboutrubbernecker.