How to profit from low oil prices

What happened?

Although oil prices (both WTI and Brent) strongly increased after the oil market crash of late April, prices are still rather low. In this article, I will show how to profit from this situation via oil-related ETFs and ETCs.

Source: Investing.com

On April 20th of this year, WTI Crude Oil marked its all-time-low of almost $-40. Never before, Oil Futures dropped below the threshold of $0. The reasoning is most likely related to speculators that held futures on physical crude oil. As the monthly rollover was approaching (i.e. investors would receive a physicial delivery), many of those had to get rid of their shares. However, due to shutdowns in multiple countries, bids were fairly low – resulting in a negative oil price. In other words: If your storage capacity was high enough, you would have received money for buying oil.

What changed already?

Admittedly, from April to July, prices significantly recovered. However, compared to the average of 2019 (roughly $60), they are rather low. Based on today’s value ($41.34), there is still sufficient upward potential to contemplate about an investment.

How to profit from low prices

In general, there are two investment vehicles (neglecting short term certificates and direct investments):

ETFs (Exchange Traded Funds) that invest in oil companies

  • Advantages: Oil & Gas ETFs (display many advantages associated with common ETFs. While expense ratios are low, it is possible to diversify your portfolio. Furthermore, your loss is limited to the amount of capital invested. A nice overview of Oil ETFs is given by ETF.com For further information on ETFs you should also see my article on why ETFs are a good start for your investment career.
  • Disadvantages: As Oil & Gas ETFs are not perfectly correlated to oil futures, you cannot fully participate in price movements. Furthermore, it is not possible to diversify between industries.

ETCs (Exchange Traded Commodities)

  • Definition: ETCs are pretty much like ETFs, except for the fact that the vendor buys oil futures instead of stock shares. Each month, to prevent physical delivery, ETCs roll over to the contract of the subsequent month.
  • Advantages: With ETCs you can directly participate in price movements, but – in contrast to a direct investment in oil futures – your loss is limited to the amount of capital invested.
  • Disadvantages: Unfortunately, ETCs also bear crucial drawbacks. First, you will likely experience rollover losses, which arise if the next month’s contract is more expensive than the current one (your vendor receives less shares for the same capital, resulting in smaller exchange ratios). Due to storage costs, this is usually true (so called Contango). Second, in the majority of cases, oil market crashes also imply higher rollover costs (due to a higher difference between futures contracts). This state ist also called Super Contango. Due to the recent Super Contango in April 2020, many ETCs display prices far below the crash (although oil prices are higher).
    • As an European investor, like me, you may also face currency risk.

Conclusion

Taken together, oil investments still feature potential gains. While ETCs make it possible to trace Oil Futures, they also display significant risk. In addition to that, you might lose money, even if prices remain constant. Thus, ETCs are rather preferable when conducting short-term investments (when expecting price increases), while ETFs are also suitable for long-term investments. However, you should still be aware of Corona, as a second wave might imply further shutdowns.

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Author: Admin
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