Yesterday crude oil traded below US$30, hitting a low of US$29.43. The shocking drop hit Australian oil companies hard. Woodside Petroleum [ASX:WPL] closed down 5% who was joined by Santos Limited [ASX:STO] who dropped 5.14%.
It was much the same for US oil companies. Concerns over oil companies borrowing billions caused panic among analysts. Big oil titans like BP Plc [LON:BP] and Exxon Mobil [NYSE:XOM] willingly damaged the health of their balance sheets. Both companies borrowed upwards of US$5 billion in debt all in the hopes to keep shareholders happy.
But that was yesterday’s news and today is a new day. Overnight oil surged 9.47%, closing at a high for the session of US$32.71 per barrel.
OPEC to offset inventories
For those of us who don’t know, oil prices have been on a one way trip down because of oversupply. Iran, the seventh largest oil producing nation, has flooded the market with oil. The aim, many think, is to put a damper on Saudi Arabia’s profits.
The cold war between Iran and Saudi Arabia has been going on for years. But recently the tensions have escalated. Tactics to hinder each other have ranged from executions to political bad mouthing. Iran now turns to producing oil in mass quantities to harm the Saudi’s.
Yet there is support for an emergency OPEC (Organisation of the Petroleum Producing Countries) meeting. The support came in the form of WTI crude futures rallying by 2.87%.
What does this mean?
A futures contract represents an underlying asset (in this case oil) to be delivered for promised price (price bought or sold) sometime in the future. If we break this down further, an increase in short term futures contracts means traders believe the price of oil will increase in the future.
And what would an emergency meeting do? It would allow those within OPEC to discuss limiting the supply of oil. Therefore a lack of supply will increases oil prices. Last week talks between Russia and Saudi Arabia boosted oil price above US$33. The take away from the meeting was a proposed oil production cut of 5%.
And there’s a chance it could actually happen. A host of smaller OPEC countries are now urging Saudi Arabia to craft a strategy which will reduce the supply glut. But the Saudi’s say it could all depend on Russia. The Saudi’s are firm on their stance for Russia to also cut their production before they give any concrete commitments.
Yet it is still early days. The recent yo-yoing nature of oil prices could also present some opportunities for Australian investors.
Higher oil prices could mean higher returns
I stated above that dropping oil prices puts pressure on our own Australian oil producers. It’s common sense when you think about it. Oil is the product that their business model depends on. If the cost is low then it make sense that earnings will also drop.
However it’s not only earnings that are affected. Investors’ confidence is a big factor of why stock prices rally or decline. So if oil prices increase, it’s not only good for business but it’s also promotes confidence for oil related companies.
Does this mean that because oil rallied last night, Australian oil producers will do the same today? Using this kind of thinking might be useful for an intra-day trader who is in and out of many trades within a single day. Yet it’s not so helpful for the average retail investor.
Yes, oil price’s rallied and it could mean slight share price gains for oil producing companies. But it’s not a safe strategy to earn reliable returns. There are numerous factors to consider. For example:
- Which oil companies would be most affected?
- At what price to buy in and what price to get out?
- How long should you hold your shares for?
And the list goes on. Using such a volatile factor (oil) as a basis to trade on might not be for everyone. It’s not always about getting rich quick. Instead, making decent sustained returns is what you should strive for.
Junior Analyst, Money Morning
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