As oil prices plunge, I want to profit from the next spike. Here’s how

A careful contrarian’s guide to betting against the oil bust

14 February 2015

9:00 AM

14 February 2015

9:00 AM

Buy jerry cans and fill them while you can. You won’t want to be caught out by the great oil shortage of 2016. Maybe that is exaggerating a little, but when you start hearing people talking about the world being ‘awash’ with oil, and read of oil companies slashing exploration and towing rigs to be laid up in the Moray Firth, you have to wonder if an oil crunch can be far behind. Someone is going to make a fortune when the balance between supply and demand flips and prices rocket again.

It is easy to fancy that it could be you. But being a contrarian doesn’t always work out. Only misery awaited those who thought that when bank shares halved at the end of 2007 it must be a great buying opportunity. I would love to say I wasn’t one of them. It is not much consolation to be able to say you only lost 90 per cent of your money, while those who bought at the peak lost 95 per cent.

So is now the time to make a fortune from a depressed oil industry, and how do you do it? It is so often the same for small investors. You vaguely know what you want to do, which is to buy some oil at today’s price in the hope that you can sell next year at a higher price. But how do you get your hands on oil futures?

You can do so via things called Exchange Traded Funds, which invest in oil futures for you. You can certainly make money when the price spikes. Had you put $100 in the ETFS Commodities Securities Crude Oil fund in 2007, for example, you would have had $200 a year later. But a year after that you would have been down to $50, and now you would have $30. What’s more, you wouldn’t have had a cent of income to show for it. In fact, oil futures pay a negative income. ‘It costs a lot of money to keep rolling over derivatives,’ says Laith Khalif of Hargreaves Lansdown. ‘Even if oil prices are going up you might not make that much money.’

At least your BP shares are still yielding 5 per cent, even if they are down 20 per cent in a year. Shares in oil services firm Petrofac are yielding even more, at nearly 7 per cent. Either of those dividends might be trimmed, of course. But then again, they could rise if oil prices rebound.

All this turns on a premise which might prove false. What if crude oil prices plunge further, say to $20 a barrel? It is not impossible. The plummet in oil prices at the beginning of December was precipitated by the decision of Opec, which usually cuts production when prices fall, to keep the taps open. It is doing so because it no longer has global dominance in oil production, now that shale production has made the US self-sufficient in oil. If Opec slashes output, the price will not respond rapidly as it did in the past. And there is every reason why Opec might want prices to keep falling. Shale oil production is on tighter margins than drilling in the Middle East. As prices fall, Canadian tar sands producers will be knocked out first, followed by US shale producers and the North Sea. Low oil prices hurt Opec producers, but they will eliminate some of the opposition.

Although the crude oil price has halved since last June, we are only just about getting to the stage where it starts to get interesting. At $50 a barrel, analysts Wood Mackenzie calculate that just 0.2 per cent of current world oil production is making a loss. At $40 a barrel (it was $46 last week), it’s 1.6 per cent who lose money.

So if the price stays above $40, oil production is likely to remain where it is. If it falls below $40 for a short period, most production will continue, because the decommissioning costs are quite high. But if it falls below $40 for a prolonged period it is going to take out a substantial chunk. At the same time, a sustained low price supercharges demand for oil, as gas-guzzlers and oil-fired boilers start to look like attractive options again. The oil market has always had spikes and troughs and no doubt always will.

So you are convinced that the slump in oil prices will rebound and want to strike a metaphorical gusher? If shares aren’t your thing and oil futures are a bit inaccessible, there is always another option. You can find on eBay a 20-year-old, 30,000-litre oil tanker for £4,900. Fill it with unleaded at £1.05 per litre and, should the price of petrol rebound to £1.40, your £31,500 investment will have grown to £42,000.

You had better check with the neighbours first, though. And HMRC: there might be some tax implications if you start flogging to friends and passers-by. Oh, and health and safety. It isn’t just the oil price which is volatile; so is the real thing. You don’t want to risk the wrong kind of boom.

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  • Damian Hurts

    Commodity prices will be forever tied to interest rates.
    One outperforming the other for years, as it has in recent years, is no longer economically sustainable.