The Price of oil is negative and the whole world is upside down. Yuvraj Thakker, Managing Director of BP Wealth breaks down exactly what happened yesterday with oil, what caused it, what does it mean for the world and India and at the end of the video we will tell you how to profit from this scenario.
OK so what exactly happened?
On the 20th of April, Oil went through an unprecedented massive price correction that saw prices on some types of contracts go as low as negative 35 dollars a barrel. This was caused by a combination of the global pandemic lockdown, the price war between the largest producers In the world causing an oversupply and most importantly the fact that all storage facilities in North America including supertankers, onshore storage and pipelines are full.
Still, how does this make the price NEGATIVE?
So the basic principle of any oil well is that it is extremely expensive to shut down a well and then, later on, start pumping again. In fact, there is a high possibility that once a well is shut down it might never return to the same output. So if the price of oil is unfavourable at the moment, the oil mining companies will never shut down production but rather store it to sell at a future time when the price is better. As we have understood that there was no physical space to store the oil, the market compensated that by giving a carrying cost to the people willing to store it. This carry cost is the reason oil turned negative.
Why is there so much oil?
The global pandemic is one part of the story. Earlier this year, the two largest oil-producing nations, Russia and Saudi Arabia had a major fallout in their relations and terminated the agreement between them to limit the amount of oil each country produced. This caused both countries to produce oil in full swing causing oversupply in the market and filling up all storage. There was a deal that the oil-producing nations agreed on but that only caused a 10% cut in production and it came too late and it created a long squeeze in the market.
What is the role of the markets in this? And what is a LONG SQUEEZE?
90% of the trading of oil is not between producers and consumers, it is between traders and speculators. This is done using a tool called futures contracts, where, and pay attention because this is important, the trader does not need to take actual physical delivery of the commodity and he or she can leverage his positions 60 – 70 times. This means that for a 100-rupee investment, the trader can trade 7000 rupees worth of oil. This becomes really risky when the amounts involved are thousands of crores. Now at the end of the contract expiry, which was yesterday, the trader could either take delivery by paying the entire amount, which they don’t have, or sell the contract in the market and buy next month’s contract which is called a rollover. This is where the people who had bought April contracts got squeezed and they were forced to sell at ridiculously low price incurring massive losses.
What’s next for INDIA and the world?
This price correction is not sustainable and we believe that the price will rebound to normal levels in a few weeks. In fact, the May futures are trading at above 20 dollars a barrel. But this has been a massive shock for the whole world and a lot of money has been lost globally, showing exactly how fragile and interdependent the global ecosystem is.
As for India, we believe this is a great opportunity. In the very short term and immediate future, the markets will move down because foreign investors will sell Indian equity to pay their oil losses. The reason they will sell Indian equity is because our markets have performed really well compared to the rest of the world and they will get the maximum money selling these assets.
However, in the medium and long term, this is a huge boon to India. These low prices will allow the oil ministry to buy a huge amount of oil at a very very cheap rate and use it over the coming months. This will help us in plugging our fiscal deficit and making our country stronger.
What does this mean for You and how can You take advantage?
We might see a cut in petrol and diesel prices but I don’t think it is too likely.
A better strategy would be to buy companies like ONGC and other oil marketing companies to take advantage of the price swings. To get a full list of our recommendations leave a comment below and we will get back to you.
For the more active traders, keep an eye on the oil prices which have strong support at 18 dollars and trade the price swings.
Whatever the scenario, please take care of yourselves and your families in this terrible pandemic. Stay healthy and stay hungry.
You might also Like.
The Link Between Mutual Funds and Compound Interest
The Link Between Mutual Funds and Compound Interest If...
