The expiring May oil contract trading for less than $0 made big headlines, but what is zero-dollar oil, and what does it mean for your investment portfolio?
Zero Dollar Oil
The trick to oil contracts, unlike similar stock options is that execution requires the delivery of a physical good. If you buy 100 options for IBM stock, on the day the contract expires, they put shares of IBM stock in your brokerage account. Obviously, this requires no effort, nor ability to “store” those shares somewhere.
When an oil contract expires, its owner has to take possession of the barrel of oil. That doesn’t actually mean that an investor drives up a truck and loads it with barrels of oil. Instead, there are numerous storage and refinery facilities where that oil can usually be directed. However, as the May contract came up for expiration, there wasn’t any room for storage (which isn’t free), and there is no demand at the refineries, so investors were looking at having to take delivery of a good that they had no place to put, and no use for. In this case, it actually would cost such an investor less to dump his contract for pennies, rather than pay to find a way to store his oil.
What Happened To Cause $0 Oil?
A sort of perfect storm happened to hit the oil markets in April and May.
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Remember that just before the coronavirus started really shutting down America, and other countries, Saudi Arabia and Russia failed to come to an agreement about the amount of oil production. Saudi Arabia has long been aggrieved at being the ones who have to cut production to support oil prices while countries like Russia pump at full speed and reap the rewards of those higher prices.
This time, Saudi Arabia decided it would no longer be the responsible party and let everyone else ride for free. It began selling oil at a much higher rate. Predictably, this led to lower prices and more oil supply in the market. This timing was unfortunate.
As the virus began to hit the world’s biggest economy, demand for oil fell off the charts. Shuttered airlines no longer needed oil to refine into jet fuel. Consumers stopped filling there cars. And all of this happened, before that extra oil was absorbed in anyway. The result is an oil market full of supply, with no demand.
How Do Low Oil Prices Affect My Investments?
There are obviously a lot more factors affecting stock prices than just the oil market, however certain investments are more susceptible than others.
If you have any oil stocks, they are obviously getting hammered. Non-giant oil producers typically have higher costs per barrel. They have trouble making a profit at oil prices below $30 per barrel, let alone single digits. This is especially true for shale oil producers in America whose break even point is closer to $40 or $50 per barrell.
Even if the virus went away tomorrow, the supply glut in the market will take awhile to work out, especially if oil producers try and save themselves by pumping faster to make up for lost time.
The other place you’ll see your portfolio taking a hit is in any commodity mutual funds, or commodity ETFs, both of which typically have a significant portion of the portfolio in oil-based investments. After all, oil is one of the biggest commodities. The tumbling prices are overwhelming any gains in other parts of the portfolio.
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As always, panic is not a good investment strategy. The damage has already been done. While a rebalance and reevaluation of your risk tolerance may be in order, simply selling off your commodity-based investments now will only lock in your losses. As for buying into such investments, that is certainly tempting, but recovery may be a long way off, and it could be substantially slower than the recovery in other areas. As such, ongoing investment into a diversified portfolio that includes commodities in a small amount is likely the best move.
This article is for informational purposes only and is not meant to be investment advice. Consult your financial professional for advice specific to your situation.