HOW AND WHY INVEST IN OIL?
At this rate, it is obvious that oil will eventually run out, and as they say, what is rare is expensive... Are you ready to seize this opportunity?
KEY POINTS
Oil is becoming increasingly rare and difficult to extract (and therefore more expensive).
Oil prices are cyclical: low prices lead to less investment in exploration and production, which leads to less future production and higher prices.
Various financial products are available to "buy oil": stocks, ETFs, turbos and CFDs.
The Oil Deficit and Peak Oil
Peak Oil: Is the end of oil coming soon?
Oil was formed in the Earth's interior millions of years ago. Therefore, on the scale of humanity, oil is the ultimate resource. Sooner or later there will be no more oil to fill our cars. We can only guess when.
Discoveries of new deposits of conventional crude oil have been in free fall since the early 1970s. Therefore, the vast majority of the world's reserves are already known, and future discoveries will not change the situation. Yet it is today's discoveries that will ensure tomorrow's production.
Some oil companies are already in decline. This is especially true of Northern Mother Oil (Brent), which peaked in 1999. Globally, most analysts agree that oil production has plateaued at around 100 million barrels of oil a day.
Technically recoverable crude oil reserves are estimated at about 2,000 billion barrels. At the current rate, this is just enough for the next 55 years. But it would be a mistake to assume that supply difficulties will not appear within a few decades, production will not stop in exactly 55 years: a gradual decline is inevitable.
In fact, this level of production will be possible until 2025 or 2030, and then decline due to the lack of new exploitable resources.
In order to mitigate the situation, it will be necessary to use more and more so-called unconventional sources of hydrocarbons, the production of which is more expensive.
The end of cheap oil
In the early days of the oil industry, oil was pumped from very generous and shallow fields, so that, graphically speaking, you "just had to bend over to get the oil up." But the late 2000s was a turning point in the history of the industry: the era of cheap oil was behind us. In order to continue meeting growing demand, it was now necessary to turn to unconventional types of oil.
The development of shale (or rather tight) production in America is one example. To produce this oil, horizontal wells must be drilled more than 2 km away. Then high-pressure water must be pumped in to fracture the reservoir rock, and finally the oil must be pumped out. The service life of compact oil wells is short: 50% to 75% of the reserves are pumped out within the first two years. All told, it took almost $900 billion in investment and 200,000 rigs for U.S. production to recover from a 40-year slump in 2010. Currently, it is believed that $50 a barrel is needed for a new well to become profitable in the most favorable areas of U.S. shale oil production, and more than $70 a barrel in the least favorable areas.
Other unconventional oil will have to be developed in the future to meet future demand:
- Canadian oil sands, which already produce several million barrels daily and break-even at about $75 a barrel;
- Super-heavy oil from Venezuela, which is very viscous and therefore very difficult to recover;
- Arctic oil, whose extreme conditions will not allow large-scale production before prices return to $100 a barrel.
In a situation where there is less and less oil, it is becoming more and more expensive to produce. This will lead to a gradual increase in prices in the short, medium and long term. It could even lead to a new oil shock.
What are the prospects for rising oil prices?
The demand for oil is growing in the medium term. There are countless uses for oil. The black gold fuels the vast majority of the 1.4 billion cars on the road, but it is also used to produce the fertilizers and pesticides needed for modern agriculture, industrial lubricants, bitumen, plastics, nylon, adhesives, and a host of other everyday goods.
Mankind is highly dependent on petroleum because it is difficult to replace:
- it has a high energy density;
- it is liquid at room temperature and therefore easy to transport (e.g. through pipelines), unlike coal or gas;
- it is easy to store, unlike electricity.
Developing countries have a growing need for oil to fuel their industries and to meet new lifestyles. While a Chinese person consumes on average 3 barrels of oil a year, a French person consumes 8, and an American 22! If all of humanity consumed as much oil as one Frenchman, oil production would have to be doubled. If we limited ourselves to China and India, we would have to increase production of black gold by 45%.
So it is not surprising that the growth in oil consumption is at the expense of developing countries.
In order to keep producing black gold, we need to pump oil, which is becoming increasingly difficult to access. The investments required to do this are enormous and risky. In 2015, for example, Shell halted an offshore oil platform project in northern Alaska with a $7 billion investment because it could not find enough oil.
In order to make these investments, future profits must justify them, so the price of oil must be high. That's why oil exploration and production is cyclical:
When prices are high, oil companies launch numerous exploration projects and put new wells into production;
A surplus of produced black gold leads to a drop in the price per barrel;
When prices fall, new production projects stop as they become less profitable;
Production dries up as old wells naturally shrink.
The market becomes tight and prices rise.
Note, this cycle lasts for several years. Currently, with low Brent oil prices, most projects are at a standstill. Oil companies are being forced to lay off employees and smaller companies are going bankrupt. This can be seen in the number of drilling jobs around the world.
Between 2011 and 2015, prices held above $100 per barrel. It was under these conditions that the U.S. shale oil industry was able to develop. In 2016, the price of a barrel collapsed to $30, and investment was cut off. In 2017, this brought prices back to their balanced level, around $60 before the covid crisis. The longer the price stays low, the greater the shortfall in future production and the sharper the price rebound will be.
Oil Price Projections
Let's summarize what we detailed above:
- oil production is becoming increasingly expensive;
- demand for oil is driven by the growing needs of developing countries;
- low prices resulting from the health care crisis will lead to underproduction in the coming years.
Under these conditions, it is clear that prices will rise in the medium and long term. Rystad Energy, an energy consulting firm, estimated in 2017 that 40% of reserves could not be used at a price below $80.
In the longer term, as oil inventories decline, prices could return to early 2000s levels, around $100 a barrel, a price that would be necessary to consider a new wave of large-scale investment.
By betting on rising oil prices, you can get a potential capital gain of about 50%.
5 WAYS TO INVEST IN OIL
1. Buy stocks of oil companies
By buying stocks in companies like Total, BP, Chevron or ExxonMobil, you are indirectly investing in oil prices. Indeed, since the core business of these companies is marketing oil, their stock price correlates quite strongly with the price of oil.
However, the correlation between stock prices and oil prices is far from perfect. Many other factors (the companies' debt levels, their reserves, or the portion of their turnover related to activities other than simple production) also influence the dynamics of their stock prices. In addition, these companies tend to diversify their activities by investing in renewable energy production, which makes the stock price different from the crude oil price.
2. Investing in oil through ETFs
An ETF (Exchange Traded Fund) is a publicly traded investment fund whose purpose is to replicate a stock market index. Just as there are ETFs that copy the CAC 40 index, there are ETFs that copy the price of Brent or WTI crude oil. They are also known as ETCs (Exchanged Traded Commodities).
Although imperfect, ETFs replicate quite accurately. It's a very practical solution for mid-term investors because you can hold ETFs for as long as you want and the management fees are relatively low. Beware, some ETFs replicate not the price of black gold, but the price of a basket of oil stocks: it's like buying stocks.
TIP
Brent and WTI ETFs are good betting decisions on long-term oil price gains. This is the financial instrument we recommend you start with.
3. Buy CFDs on Oil
CFDs (Contract For Difference) are derivatives that allow you to bet on the difference between the price of oil when you buy a CFD and when you sell it. You can bet on both rising and falling prices.
The main advantages of CFDs are
- ease of use;
- continuous quotation;
- leverage
The disadvantages are
- the difference between the purchase and sale price, which can be significant. This acts as a hidden fee;
- if you hold a CFD overnight, i.e., for several days, you will be charged a fee, which varies from platform to platform.
CFDs are mainly designed for the short and medium term. To trade CFDs, you need to open a special account in the trading platform
4. Buying Oil Turbos
A turbo is a derivative whose price depends on the underlying asset, in our case oil. They are a bit more complicated to understand than CFDs. The main characteristics of a turbo are as follows:
- Expiration date - is not mandatory, in this case we are talking about an unlimited number of turbos.
- The price of the stock - is set in advance.
- Ratio.
On the redemption day, you will receive the difference between the oil price and the option price, multiplied by the ratio.
You don't have to hold the Turbo until expiration, you can sell it at any time. Be careful, if the price of oil falls below the option price, you will lose your bet.
The advantages of a turbo for investing in oil are
- Leverage, which varies depending on the strike price and maturity;
- The price of the turbine is directly related to the price of oil
On the other hand, the deactivation barrier represents an additional risk. Therefore, we advise you to buy turbos whose downside price is low and will probably never be reached; around $35 for Brent.
5. Buying Futures Contracts
Futures contracts are the "purest" form of investing in oil. In theory, when your WTI futures contract expires, your barrels are delivered to Cushing (a small town in Oklahoma and, incidentally, one of the world's major oil centers).
In practice, your contracts are closed before they expire. So there is no need to look for a tank to store it in; whew!
The advantages of forward contracts are:
- the ability to use leverage;
- lower commissions than CFDs;
- the ability to influence forward prices (e.g., by contracting for delivery in 1 year)
On the other hand
- A 1,000-barrel futures contract (500 for E-mini);
- Few platforms provide access to these products.
You can check out the full list of brokers to bypass.
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