019: What Is Going On With Oil?

Future Contracts for Oil Negative for First Time Ever [1:16]

How Does This Impact Our Economy? [5:27]

Your Dad Joke of the Week! [12:50]

Other Potential Impacts from these Oil Prices [13:49]

Some Ways You Could Take Advantage of This [19:38]

Where Do We Go from Here? [22:27]

 

Links & Resources

Jim Cramer on WTI price plummet

This oil price crash isn’t as bad as it seems — here’s why (CNBC)

“Contango” meaning (Investopedia)

 

Social Media

Facebook

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YouTube

 

Full Transcript

Intro:
Welcome to the Invested Dads Podcast, simplifying financial topics so that you can take action and make your financial situation better, helping you to understand the current world of financial planning and investments. Here are your hosts, Josh Robb, and Austin Wilson.

Austin Wilson:
All right. Hey, hey, hey. Welcome back to the Invested Dads Podcast, Austin and Josh here to bring you some fun and exciting information about crude oil.

Josh Robb:
Crude oil. So Austin, it looks like you got some hair product in there. Is that something new?

Austin Wilson:
Well, crude oil is on sale now, so I got a load of oil in my shed and I’m just trying to use what I got. Don’t need to go to the store.

Josh Robb:
There’s so many applications for oil. You don’t even know.

Austin Wilson:
In all seriousness though, Ohio, we’re in Ohio, we’re during the coronavirus shutdown, we’re all locked in our houses. Barber shops are closed.

Josh Robb:
Barber shops are closed.

Austin Wilson:
And so I am running, I got a mop on my head here and I am not comfortable cutting my own hair, so I’m going to let it grow until I look like Rapunzel.

Josh Robb:
Rapunzel. That’ll be a little while. But you’re right, it is getting very long.

Austin Wilson:
We’re hoping to be back to work by then.

[1:16] – Future Contracts for Oil Negative for First Time Ever

Josh Robb:
Yeah, definitely. So oil, right? So Monday, this Monday, which would make that the 20th. 4/20/2020, we saw for the first time ever, future contracts for oil fell negative. So that means that I, having a shed in my backyard, could have been paid to hold all this oil. Is that right, Austin?

Austin Wilson:
Well, first of all, let’s start with explaining exactly what a futures contract is. So first, you’re buying a commodity. So oil is the commodity we’re talking about at a set price to be delivered in the future. So some companies like airlines or companies that use a lot of oil or different commodities use this to hedge against price increases. So for example, an airline will set in on a price, they’ll lock it in for the next month, for the next quarter or whatever that may be. And they’re able to then better budget those costs because they can fluctuate substantially. They can budget those variable costs over time.

Josh Robb:
Yes. And this isn’t anything new. A lot of companies do that. So if I’m a cereal maker and I am worried about the price of wheat for my cereal, I can hedge that cost by doing those types of future contracts.

So a lot of commodities have this, so companies do this to just really streamline and better regulate the price that they’re paying for the commodity that they know they need. Who else does this though? Or is it just those companies or are there traders involved?

Austin Wilson:
Yeah, there’s definitely traders involved. And that is what extrapolates kind of the craziness that you see in the markets. As we’ve seen specifically this year, specifically over the last week or so, it’s been bonkers. But yeah, these traders, they buy these contracts. They really are betting that the underlying price will go up and when the underlying price goes up, their future contract is then worth more. So then they can sell that contract or the contract is like a right to buy it at a price. They sell the contract itself, not the commodity, to someone who actually wants the commodity and they can make a profit on it.

So it’s all about buying low and selling high, in a perfect world, which I bet some people got that wrong this week. But what happened this week specifically was that the May futures contract was set to expire the next day. So due to the little demand for the actual delivery of the oil, the value of that contract dropped dramatically and the traders did not want to hold these contracts all the way until maturity where they would then be forced to sell it a lower price as they were trying to move the next month or whatever. So the June future contracts on the other hand, so that was May. June future contracts, still around $20 a barrel, plus or minus. So this same thing could happen when those contracts are about to expire in about another month if demand for oil has not increased. So that’s something we’ll be watching because, whew, it’s been a roller coaster.

Josh Robb:
Yeah. So in a sense they just keep rolling these contracts until if they ever want it, they could keep the contract till it expires and then take delivery or continue to buy the next month’s or the futures contract to keep rolling that until the price is right and they kind of get out of the game.

Austin Wilson:
Exactly.

Josh Robb:
So at this point though, on Monday, it was kind of this, no one wanted it. So not only the traders, they didn’t want to hold on to, because they didn’t want to take possession. But the people they usually sell it to are saying, “We got enough oil already because demand has been so low, we don’t have room to take this new shipment of oil.” And so that’s what was driving this price down for these future contracts. Because just nobody wanted it.

Austin Wilson:
And on side note, the capacity really is an issue. So everyone who wants to buy oil has bought all the cheap oil they can buy and their stockpiles are filled and every tank in the world is filled and we’re still too much. So what’s happening is oil tanker companies-

Josh Robb:
They’re just parking out there.

Austin Wilson:
They’re parking out there and they are making bank on just being a storage place for oil.

Josh Robb:
I read an article I was saying one of the spots is kind of strategically placed to get to any of the big economies. So you’re kind of off the coast of South Africa or South America. It’s kind of in that area where you can say, “I can quickly get to where I need to,” which if I remember right, that’s also where some of those crazy pirates are as well. So I wonder if you’re going to see an uptick and security needed if there’s more and more of these tankers just hanging out doing their thing.

Austin Wilson:
I would say that is not without risk. Some drug cartel is going to load up on cheap crude.

[5:27] – How Does this Impact Our Economy?

Josh Robb:
Yeah. So that’s what happened over this last week with future prices. But in general, oil’s been getting cheaper and cheaper.

Austin Wilson:
Oh, for a while now.

Josh Robb:
How does that impact our economy? What does this low oil price do for our economy here in the US?

Austin Wilson:
For sure. So we’ll actually, let’s think about this in two different ways. So number one, think about how it impacts the stock market. And number two, think about how that impacts the economy, or it’s really the way around. We’ll talk about the stock market and how it impacts that first. And we’ll also talk about how it impacts the economy overall. So the big picture really think about it, it’s all about supply and demand. It’s literally economics 101. It’s like if you took Econ 101 in college, you learn about supply and demand.

So for example, if demand is held constant, so if no more people want something and supply goes up, there’s more of an out there, then prices go down. And this is really what we’ve seen with global oil production. Oil production has just continually increased over time. Demand is growing but not as fast so prices have gone down recently a lot, excluding this recent OPEC Plus cut that we got a couple weeks ago. So if supply remains constant, but demand drops, as we’re seeing in this economy. So they kind of cut back on oil production. Demand is nothing. People are not producing, people are not traveling, then prices drop as well. So what happened here is that you’re getting hit with both sides. Your supply is pretty high and your demand is pretty low, which caused oil just to tank. Yeah, it’s really not been great.

So the issue here is that oil companies, aside from the tankers that I kind of talked about, they’ve all been sold off because all areas of their industry is being impacted by this from all the way in the drilling and exploration to the retail operations and everything in between. So that is impacting that. These companies really are generally expected to earn very little or even no profit, which is crazy cause they usually earn billions of dollars in profits and this uncertainty for a product that’s pretty essential for travel and manufacturing around the world has really caused volatility throughout the equity market and just weakness throughout it as well. I will point out that the energy sector is much smaller than it used to be. So the impact of the market probably would have been a lot worse had this happen 10, 20, 30 years ago. So that is kind of from the stock market side of things. But it-

Josh Robb:
Yeah. And you talked about the size of that in our economy is a lot lower. We were a net exporter the last couple of years. We got to the point where we used to be so reliant on oil being imported because of our demand.

But as we’ve gone with the fracking and increasing our ability to produce it, we were actually starting to export, which was compounding that supply issue because now we’re one of the exporters, not the demand seekers. So yeah, we’ve been adding to that, but it’s also helped our economy by putting less reliance on that. We’re less freaking out when the price is moving all over the place.

Austin Wilson:
True. So I guess if we take a step back and look at it from an economic standpoint, there are pros and cons to this oil price weakness. So on the positive side, cheap oil means cheap fuel of all kinds. Cheap gas for you and me. But we’re locked down and we’re not really traveling.

No one’s really flying airplanes. And that’s kind of putting a damper on excitement we would have from cheap gas. But I did have to get gas recently and it is great to buy gas for less than $1.20 a gallon. You feel like you’re stealing it.

Josh Robb:
I just was thinking back to when is the last time I remember it this cheap and I mean just crazy and I was filling up my tank for my lawn mower because I needed to get that filled up, despite the snow we had a week ago, it still needs to mow my lawn. And so as it’s filling it up, I’m thinking, “Man, it’s so cheap.” And then when you use those Kroger points and then it’s even cheaper and you’re like, “Oh under a dollar?” It’s crazy.

Austin Wilson:
I know. Yeah it’s amazing. My motorcycles take premium, or one of them does anyway. I run it in both because I don’t use it that much. But even the premium you can get for like a buck 79 a gallon. Crazy. I love it. So that is a good thing, but we’re not really using the gap to take the full advantage of that right now. But on the negative side, a lot of people are employed by the oil industry and there’s a lot of uncertainty there right now. So there’s likely a lot of people with reduced work and income, at least on the upstream and the exploration and the drilling side of things. So that’s not a good thing at all. And also, oil is the single largest traded commodity in the world, and when demand is down, trade is down and trade is almost always favorable for the global economy as a whole. So that is the downside. But I want to put a neutral side into it as well.

With oil being down and people not having a ton of money because we’re kind of going into a COVID-19 recession or whatever, that is probably going to put a damper on inflation expectations going forward for at least a while because people aren’t buying as much, energy prices are low. So I would imagine that this is putting any Fed rate hikes, way into the future. So you’re looking down the road at least a year or two or more because this is going to take a while to work itself out.

Josh Robb:
And with inflation too, I mean, all of our goods get to our stores somehow or another using oil and gas, right? I mean through the trucks, through the shipping. And so if that’s all cheaper, you’re right inflation, they don’t need to be raising their prices. And so you’re right. So cheaper gas is not only good for us filling up our tanks of our cars, but it’s good for the consumer in general because the goods and services that we’re buying, those need to get to where we’re at some way or another. And that’s through mainly trucking. And so gas is cheaper. Guess what? Your products are cheaper and so-

Austin Wilson:
Oh, I don’t think so. I don’t think so

Josh Robb:
Well it’s cheaper to produce.

Austin Wilson:
Exactly. I think that the corporations think of the Walmart’s or the Kroger’s or whatever of the world, they’re going to look at this as the one favorable item on their income statement for the next couple quarters.

Josh Robb:
I don’t expect them to lower costs, but you’re right. What it’s going to do is cushion everything else by saying, “Okay, at least we made a little bit above what we expected to on our cost of shipping.”

Austin Wilson:
Yeah. If they can hire enough drivers, then they will be able to have some favorability on at least one piece for the next couple quarters. So one more thing. I think it is highly likely that we’re going to see a lot of consolidation in the energy industry. A lot of mergers potentially come out of this in oil in general because the bigger, less debt leveraged more cash heavy oil companies, they’re probably going to be able to buy smaller companies that are either directly in line with what they do or upstream or downstream of that for fractions of what they could have a year or two ago.

So you couple that with some ridiculously low interest rates that the Fed has given, that really trickle through to them, where they could either borrow or issue debt to fund. And I eee some consolidation being definitely a reality for the energy industry in the near future.

Josh Robb:
Yeah, I agree. And we’ve seen that in the past when there’s been that fluctuation is … there’s a lot of small energy companies that have a pipeline or a well that’s strategically, they were able to get that a larger company would just love to gobble up if they could and make it part of their network.

[12:50] – Your Dad Joke of the Week!

Josh Robb:
All right, so let’s take a break real quick and do the dad joke of the week.

Austin Wilson:
Josh, I’ve been waiting all week for this.

Josh Robb:
This is, it’s long overdue. All right. So we were talking about shipping oil, right? Okay. Do you know how much oil did it take for Columbus to reach America?

Austin Wilson:
No, I do not.

Josh Robb:
Three galleons, galleon being the ship.

Austin Wilson:
Was that was really the name of the ship?

Josh Robb:
Well, they were., galleons is the type of ship. They’re the Pinta, the Santa Maria, and something else. I forget my history.

Austin Wilson:
So you brought history.

Josh Robb:
I did bring in history.

Austin Wilson:
And a joke together.

Josh Robb:
It is.

Austin Wilson:
That’s a dad joke.

Josh Robb:
That’s right there. Follow up by the way. What do you do with crude oil by the way? Talk about receiving that and holding it.

Austin Wilson:
I mean I put it in my hair.

Josh Robb:
No. With crude oil, you need to teach it manners and then it’s no longer crude.

Austin Wilson:
Crude oil, the Netflix original of the commodities.

Josh Robb:
That’s right.

[13:49] – Other Potential Impacts from these Oil Prices

Austin Wilson:
So Josh, what are some other impacts to the energy industry? Things that are going to change for sure in this new kind of environment we’re going to be in.

Josh Robb:
So one of the ones we talked about here in the US, a big trend we saw was fracking, is that there was some new technology for getting oil in the shale area where you could kind of get oil out of places that before were just kind of cost prohibitive. But when oil was $80, $90 a barrel, it made sense to do that. Well when oil is $20 a barrel or less, there’s no new exploration happening. In fact, wells they already have, I mean just doesn’t make sense to shut them down cost wise, but they’re not making new wells. So exploration is not happening. They can’t justify those costs. Not only here in the US but around … deep sea. There’s a lot of costs to finding and drilling for oil. And so with the cost so low, there’s no exploration. Now the problem is it takes a while to get new oil.

So if you stop now, you don’t see the impact here, you see it down the road, five, 10 years when demand picks back up and you say, “Oh well, some of my old wells are dried up. I hadn’t been looking for new ones because it didn’t make sense.” And so there could be a disruption down the road because of this kind of pause and exploration.

Austin Wilson:
Josh, I got a random dad joke I had for you.

Josh Robb:
Oh, it popped in. Let me hear it.

Austin Wilson:
It’s an oil related one. So what did the oil company call the ship that looks for spots to drill wells?

Josh Robb:
I’m not sure. What do they call it?

Austin Wilson:
Dora.

Josh Robb:
Dora the Explorer?

Austin Wilson:
The Explorer.

Josh Robb:
The Explorer. Like it. One other thing is alternative fuels, right? So that was a big push, right? Again, when oil is $80, $90 a barrel, they’re like-

Austin Wilson:
Finding alternatives.

Josh Robb:
“Hey, what else is out there?” This is killing the environment. It’s not great for carbon in the air and all that crazy stuff. Getting it out can cause problems. We saw the oil rig disaster down in the Gulf of Mexico on the Deep Horizon. It’s not the cleanest to stop. It’s called crude oil for a reason. It’s messy.

Austin Wilson:
It’s gross.

Josh Robb:
So there are alternatives out there. We have solar, you’ve got wind, you’ve got all the cool stuff. But with the cost so cheap, it’s hard to justify that. And for the average consumer, especially now they don’t want to pay more for electricity or for their gas or their all their stuff if there’s a cheaper source, and that’s oil right now, that’s fuel. That’s these … So there’s really not alternatives. And you look at electric vehicles that again, when gas is $3.50 a gallon, sure I might consider an electric vehicle.

It might be cheaper, but again, when you’re paying $1.20 for gas, sure I’ll keep driving my gas vehicle around. It’s cheaper.

Austin Wilson:
So Tesla, it’s an electric car company. Their stock during this whole oil sell off has gone bonkers. It’s the other way you would expect. So you think that cheap oil is going to make people buy gas. You’re going to buy a Hummer or whatever.

Josh Robb:
Yeah, it’s an expensive electric car.

Austin Wilson:
Tesla stock keeps going up.

Josh Robb:
I know. It’s hard to explain. That one’s a weird one.

Austin Wilson:
So yeah, I think you’re exactly right. It just is not making as much sense to consider other alternatives at this point. Now, I think that it’s only a matter of time until that gets back to where we would think it would be or where it was, but we’re going to be in this environment where we have cheap oil for a long time because the demand’s not there.

And like you said, a lot of those existing oil places they’re still producing at least what they have to keep their refineries, to keep their or whatever, running and cost-effective.

Josh Robb:
Yeah. And then you talked about OPEC.

Austin Wilson:
So we’re going to be on low oil.

Josh Robb:
And OPEC, I mean they’re reliant on that for their economy. That’s where a lot of those countries, that is their primary source of income to run their country. And so you’re right, it’s not like they’re just going to up and stop, regardless of what-

Austin Wilson:
Oil will be lower for longer. So I started driving and gas was $4 a gallon. So I remember filling up my little Honda Accord when I was 16, it was like $50 bucks to fill up my little … and that was not fun. But I hope that now those high school kids can be grateful when they fill up their car and it costs them $20. Be a good thing.

Austin Wilson:
So I think that there’s some terms that I have been throwing around. It’s been on TV that we should talk about. Okay.

Josh Robb:
All right.

Austin Wilson:
These terms, number one: Contango. Right. Sounds like a dance. I looked this up. It’s not a dance, but my wife and I had been watching the Zorro movies because the first one’s on Netflix, The Mask of Zorro. Second one was on Amazon or something. The Legend of Zorro. Great movies. Antonio Banderas, Catherine Zeta Jones, Anthony Hopkins’ in the first one. Phenomenal movies. I think they did the Contango. Nah, just kidding. They did the tango, I think. But it’s not a dance. It’s really when future prices for a commodity, so the price of those futures contracts are higher than the spot price. So this occurs where an asset is expected to rise over time. And this has definitely been the case lately where oil seems to have nowhere to go but up.

But this week oil has taken on the term Super Contango, which is a super exciting dance, or it’s actually just really exaggerated expectation of different prices between spot and futures prices. So totally weird terms. Totally cool terms. Put those in your notebook for the day.

Josh Robb:
I learned something new.

[19:38] – Some Ways You Could Take Advantage of this

Austin Wilson:
So I think we should also probably talk about some ways that we could have some exposure, some investment in this trend. Now I do want to make the disclaimer as always that you should always talk to your financial advisor about what you’re going to invest in or if this is a good fit for your financial situation, your risk tolerance. I’m not even saying these are great investments, but these are just ways to get exposure to cheap oil, to oil in general or whatever.

So a couple ETFs, exchange traded funds. Number one is USO. It is the oil ETF and it’s been all over the place today specifically on the 21st of April. It’s had to, that’s had so much demand with how cheap it’s gotten. They’ve had to do some weird restructuring and things like that, but that’s one way. Another one is the IEO ETF. That’s an exploration and production ETF. There’s a OIH, the Oil Services ETF-

Josh Robb:
They were one letter off of having a very good ticker.

Austin Wilson:
I know.

Josh Robb:
OIH? I mean, come on. Were they typing too fast and missed it? I mean, OIL who does not have that as a ticker if you’re an oil … Come on.

Austin Wilson:
They know that Marathon is headquartered in Ohio. Then there’s XES is another one, that’s an oil and gas equipment and services one. So there’s some ETFs to kind of get exposure to different areas of oil. But then you could also think about individual oil companies, which my goodness, they have just been hammered this year and-

Josh Robb:
It took a little beating.

Austin Wilson:
It depends on how you look at things. So obviously some of the smaller, more leveraged companies are going to have a very rough time ahead may get bought up by larger companies. Who knows what’s going to happen. But some of these larger companies, they’re going to do fine. And they’ve been through, maybe not exactly what’s going on right now, but similar situations where oil prices have dropped substantially and they’re going to be around. So things like Chevron, Exxon Mobile, these diversified, huge, enormous oil companies, they’re going to definitely at some point, probably come back.

But how long and how far away that is, who knows? So that’s kind of an up in the air thing. But you could also look at something like I mentioned before, specifically being in Findlay, a company, like Marathon Petroleum Corporation, ticker MPC. That is one company that does more of the refining and retail side of things with Speedway, they own Speedway.

So those are some ways that you can get exposure to oil. And again, I will say it twice. This is not saying that now’s the time to go all in on oil or oil stocks. But for a portion of some of your investment portfolio, it could be a fit if you talk with your advisor and they agree.

Josh Robb:
The only thing going all in an oil are my chicken nuggets when I deep fry them. That’s it.

[22:27] – Where Do We Go from Here?

Austin Wilson:
Love me some nuggets. So I guess you could ask the question, where do we go from here? Because I’m going to tell you my short answer is I don’t know. And I think that everyone who really is going to be honest with you is going to tell you that because it’d be easy to say that this is the bottom for oil, but you could’ve said that yesterday.

So it’s hard to time these things. But overall, one would anticipate that over time as the economy opens back up and people start traveling again, people start flying again, people start doing whatever, buying things, manufacturing things that over time, things should get a little bit better for oil and for oil companies. Again, we don’t know how long that will be out. We don’t know what exactly that will look like. We don’t know if there’s more to go down, but over time one, would imagine that there should be some upside from where we’re at.

Josh Robb:
So today we learned that future thing was kind of an anomaly. It didn’t have so much to do with oil itself, but more traders in contract prices and stuff.

Austin Wilson:
Yes.

Josh Robb:
But we do know that oil is cheap compared to where it’s been. It’s been on a downward trend for awhile.

Josh Robb:
But also to know that in the long run there’s people that benefit from low oil prices, just the same as the people who benefit from high oil prices. They’re just different parts of our economy. So overall, I don’t think any of the developed world can just get rid of oil right now. They’re not positioned that way. So oil is still is in demand, although it’s a little bit less demand right now. Kind of like you were talking about, Austin.

So I guess I can cancel my future contracts. I cleaned out my shed for nothing. I even had a business card made. I’m going to be an oil baron and you’re were going to have to call me “Slick” from now on. That was going to be my oil barrel name. But I guess I’m going to cancel all that and go back to just housing my lawn mower in the shed.

Austin Wilson:
That’s okay.

Josh Robb:
I learned something. As always, hopefully you did as well. Check out our website at theinvesteddads.com. We have a timeless piece of Eight Principles for Investing. They’re free. Just sign up for that to grab it.

Austin Wilson:
Thanks for being here for one, number two. We would love it if you’re not subscribed, if you would subscribe so you can listen to the podcast every week. We put these episodes out every single Thursday. Also, we’d love it if you’d leave us a review on Apple Podcasts and yeah, if you have any ideas for future podcast episode topics, any questions, comments, concerns, anything, email that to us at hello at theinvesteddads.com and we’d appreciate it if you’d share this episode or any other episode we put out with your friends and family if you really enjoy it and think they would too.

Josh Robb:
Yep. Remember, cough into your elbow. Don’t touch your face and don’t touch other people’s faces. Stay safe out there.

Austin Wilson:
That’s right. Thanks.

Josh Robb:
Have a good day. Bye.

Outro:
Thank you for listening to The Invested Dads Podcast. This episode has ended, but your journey towards a better financial future doesn’t have to. Head over to theinvesteddads.com to access all the links and resources mentioned in today’s show. If you enjoyed this episode and we had a positive impact on your life, leave us a review. Click subscribe and don’t miss the next episode.

Josh Robb Austin Wilson worked for Hixon Zuercher Capital Management. All opinions expressed by Josh, Austin, or any podcast guests are solely their own opinions and do not reflect the opinions of Hixon Zuercher Capital Management. This podcast is for informational purposes only and should not be relied upon for investment decisions. Clients of Hixon Zuercher Capital Management may maintain positions in the securities discussed in this podcast. There is no guarantee that the statements, opinions, or forecasts provided herein will prove to be correct.

Past performance may not be indicative of future results. Indexes are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.