Sometimes very strange things happen in the financial markets. Yesterday was one such time. It was not do to with the stock market, but rather the oil price.
Oil is split into two main varieties, Brent and WTI. The latter stands for West Texas Intermediate, and is extracted from oil fields in the US. In order to buy and sell oil, people use futures contracts. These basically mean buyers pay a price now for delivery of oil at a date in the future.
Yesterday was the last day in which anyone could buy or sell the WTI future for delivery in May. Now, as the Covid-19 pandemic has ground industries to a halt, it is logical to think not many people would need to buy oil. Think of airlines such as EasyJet and Ryanair which have seen fleets grounded and share prices plummeting. Usually these firms buy huge quantities of oil, but not at the moment.
So believe it or not, the price of the May WTI future dropped to negative $37 per barrel. That’s right — if you wanted a barrel of oil you would be paid to take it!
How does the oil price impact companies?
I mentioned this briefly above, but many sectors rely on oil in some way. Airlines need it for planes. Supermarkets need it for petrol garages. In an indirect way, any firm with a large distribution network (think Royal Mail, Eddie Stobart, Ocado) will also be impacted due to the demand for petrol.
Obviously, it can be good and bad depending on which company you are looking to invest in. For a moment, consider oil extraction and trading firms BP and Royal Dutch Shell.
Slippery slope
The fall in the oil price over the past few months has hurt the share price of both firms. The BP share price has fallen 31% since early March, Royal Dutch Shell has fallen 29%. This puts both firms at multi-year lows. It should come as no suprise that this has happened given the high correlation between the oil price and the business operations of the two firms.
Simply put, a lower oil price reduces the profit margins for both businesses. Yet with the move yesterday, I actually think this could make oil firms a buy for investors.
This is because previously the price of oil was low, but not at such a painful level. Large oil exporting countries such as Saudi Arabia could still be profitable with oil around $25 a barrel. So the oil governing body (OPEC) only went for limited intervention. Now, however, the move is so severe that action has to be taken. OPEC will likely insist on a large cut in production in order to boost the price of oil.
Further, this is only a temporary glitch in the oil price, as companies are not demanding oil for May. As soon as the global lockdown is lifted, and people return to flying, driving and generally trading, demand for oil will bounce back. This should be reflected in a bounce in the share price for firms such as BP and Royal Dutch Shell.
Therefore, buying the shares now could be a very smart move if you are prepared to wait for OPEC intervention to cut supply and a post Covid-19 demand surge.
