• US tariff’s on Mexico – not great for car manufacturers – an average car part produced by a US manufacturer crosses the border something like 8 times in the production process
• US / China tariff’s on each other– Not great for…well a lot industries…although not too bad for a lot of other countries (including Mexico actually) who have seen their exports to the US rise as companies are shifting their supply chains
• China’s swine flu crisis – something like 22% of China’s pigs have been killed from swine flu…which is important when you consider that China raises ~50% of the world’s pigs and China’s pork industry is something like a $128B USD industry….
• Brexit uncertainty – Theresa May has officially resigned and there is a Brexit deadline on October 31^st…so something should finally get decided there…maybe? The front-runner to replace her is Boris Johnson who is for a hard Brexit. Fun fact, he looks A LOT like President Trump. I’m not convinced that they aren’t secretly twins:

But despite everything else that’s happening, I want to take today to talk about oil. Why?

1. Well first, because energy fascinates me…probably worth understanding something you likely couldn’t live without (I get it…humanity used to do this…but it’d be pretty damn hard to live without this today)
2. And second, because oil is one of the things that pretty much everything has a financial impact on and understanding what is happening there requires you to be in touch with everything else

So let’s start off with what has happened in oil markets recently. Prices (of WTI crude for anyone interested) are down ~30% from their high last October, and ~20% from late April 2019:

This selloff has primarily been driven by traders reversing their positions on oil (basically bunch of people sitting on a trading floor in NY stopped buying oil and started selling). Why?

Well there are two sides to oil: Supply and demand. And at different times one or the other will drive changes in the price. Back in 2015/16 it was supply. The US shale boom made the US the new marginal producer of oil and it starting pumping out a ridiculous amount of oil which floored prices from ~$100/barrel to something like $27/barrel at one point.

Now it’s demand.

It’s REALLY hard to predict exactly how much oil the world is going to need. There are a bazillion inputs and people are usually wrong when they try to guess this. One thing that people use as a proxy is global growth. If you think about it, more oil is used when the economy is growing. Companies are expanding their operations, buying new plants, producing more, and running their giant machines. People are taking trips flying to Mykonos and driving around everywhere. All this uses a ton of oil and so the price goes up. When growth is slowing the exact opposite happens.

Is global growth slowing? Well a lot of people certainly seem to think so..or at least think that is a very real possibility going forward. The tariff’s I mentioned earlier will definitely not help increase global growth.

So why should you care about all of this: Well beyond the fact that this is a troubling signal for the global economy, the oil & gas industry employs around a million people and supports a variety of other professions in the US and while $50 a gallon will not cause too many of them to lose their job, once it gets below $45, quite a few oil companies stop being able to produce oil at a profit and tons of people will lose their job. AND any hope of making renewable energy significantly more cost competitive will require higher oil prices.

Also probably a good idea to pay attention to oil in general – the car you drive (probably), the plane you fly in, the clothing you wear (probably produced somewhere far away), and pretty much everything else you consume or use is impacted by it.

By the way, any of you looking for a trading recommendation for oil – my recommendation is to not trade it unless you really know what you are doing. Because of the way oil is traded most ETFs do a horrible job of tracking the price of oil and most of the time you end up hemorrhaging money b/c of management and transaction fees / natural losses from constantly rolling futures contracts.

Now for a random ending note. I know I said it’s really hard to predict oil demand. Predicting oil supply is also extremely difficult. The US publishes inventory data all the time, but there are a lot of emerging markets where that data is harder to determine. Here are a few fun examples:

• In 2013, a Palo Alto startup called Orbital Insights started to calculate the real time supply of oil using satellite images to of oil tanks. These tanks had floating lids, basically the more full the tank the higher the lid goes and the emptier the tank, the lower the lid. The sun casts a reflection on the inside of the lid based on the height of the lid, and using the changes in those shadows, they could estimate the oil stored in ~20,000 tanks around the world. Pretty cool right?

• Back in 2016 when OPEC and Russia were trying to limit oil production to bump up prices, they were met with an interesting alternative source of supply. A lot of oil was being stored off the coast of Singapore in ships (tens of millions of gallons). Now normally when this happens, it’s because traders / oil companies have locked in an agreement to sell oil at a certain higher price in the future. The way oil trades is there is a price today, and then predicted prices at different time horizons in the future. If the price in the future is higher than the costs of storing the oil, then its profitable to store the oil in ships and sell it at some future date which you have locked in the price for today (assuming you can hang on to it). However, in this case, the future price didn’t actually make it profitable to have done that (it costs ~$40k a day to charter a tanker and one tanker can hold ~2M barrels of oil). So this implies that a ton of oil was sitting offshore…unsold…just waiting for prices to rise. So when OPEC and Russia started cutting supply and raising the current price of oil, a ton of these ships came back to shore and started selling their oil, which prevented prices from rising for far longer than anyone imagined. (The US also ramped up production a lot more, which didn’t help either). Red dots in the image below are oil tankers off the coast of Singapore.

 

As always, invest smart, not hard!

Readwritemoney

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