Free fall of crude oil
An increased supply and a decline in demand because of the coronavirus have temporarily pushed the oil price down to USD 20. This commodity has not been this cheap for almost 20 years.
You have to go back a long way to find a crude oil listing of around USD 20 per barrel. The price for a barrel of crude oil did not fall below the USD 30 mark per barrel even at the height of the financial crisis. The end of 2001 was the last time that oil listings fell to USD 20 as a result of the terrorist attack on September 11, 2001.
Since the coronavirus has been spreading rampantly, the price has come under extreme pressure from both the supply side as well as the demand side. Demand has fallen rapidly in a short time because of the coronavirus and attempts to limit its spread. Airlines worldwide are canceling flight plans, and production facilities are being shut down or production has been slowed significantly. It is difficult to estimate how long demand will remain subdued.
Oil glut from Saudi Arabia
The supply is also increasing. An unsuccessful attempt was made by the Organization of Petroleum Exporting Countries, OPEC, and Russia to reduce supply by limiting production and thus support the price. Russia rejected the idea, and Saudi Arabia flooded the oil market with the goal of compensating for the price decline with a higher sales volume. During the night of March 9, the price collapsed by 30 percent and has continued to decline since then.
Bad news may continue about the spread of the coronavirus as well as efforts to limit the number of infections. It also appears that Saudi Arabia is willing and able to increase production to the maximum. And yet, it is probably not the worst moment to establish long-term positions in crude oil.
Futures contracts or oil equities?
Investors have various options to participate in an increasing oil price. For example, they can invest in equities of promising oil companies to indirectly participate in the oil price performance. Or they can invest in oil futures contracts.
The Vontobel Oil Strategy Index does both. Depending on the form of the oil price futures curve, it reflects investments either in equities or in futures. In a contango pattern (spot prices are above the forward prices), roll losses occur in case of an investment in futures. In order to minimize roll losses in a contango situation, the index follows oil equities in this case. If spot prices are lower than forward prices (backwardation situation), the index reflects an investment in futures and participates in possible roll gains. Among other things, investors bear the credit risk of the issuer.