Crude oil is one of the best-known commodities in the world. The proven global reserves (considered to exist with 90% certainty) of this precious commodity are close to 2 trillion barrels, with unproven reserves driving this number significantly higher - twofold or more.
On any given day, the 7+ billion people of Earth use roughly 93 million barrels of crude oil to fuel their cars, power their homes, or as ingredients in the manufacturing of a wide range of products.
The apparatus supporting the crude oil industry is equally extensive. The sum of the gross domestic products of every country on earth is believed to be somewhere between $80-90 trillion. Of that, it is estimated that crude oil activity represents about 2-3% of that sum.
Despite the widespread penetration of crude oil into almost all of our daily lives, or because of it, the value of a single barrel of crude oil still fluctuates frequently - and at times wildly. Case in point, the last 52-weeks of trading in the oil patch, which have seen prices drop into the low $40s per barrel, as well as a spike above $75 per barrel.
That's some range for such an abundant resource.
Digging into the narrative behind the numbers, one of the biggest stories affecting crude oil in 2018 was the fact that the United States pulled out of the Iran Nuclear Agreement. While many other signers of the treaty argued that Iran was complying with their end of the deal, the United States took a different stance, and exited an agreement which had essentially lifted international sanctions on Iran in exchange for a suspension in their pursuit of nuclear capabilities.
After exiting said agreement last summer, the United States then organized an international boycott of Iranian-produced crude oil. The stated purpose of the boycott was to reduce oil revenues to the Iranian government in an effort to bolster the leverage of the United States (and its allies) in the negotiation of a new (and theoretically more effective) agreement.
Because oil production and oil consumption are so closely aligned, the removal of Iranian oil from the global supply chain (as a result of the boycott) threatened to create a shortage in the market. In anticipation of that development the United States requested that the Organization of Petroleum Exporting Countries (OPEC) increase their daily production to offset expected losses from Iran.
While OPEC did ultimately comply with this request, the Trump administration (at the 11th hour) decided to issue "waivers" to many countries dependent on Iranian oil, which effectively allowed them to continue to purchase oil from Iran without the threat of penalty from the United States.
The impact of the waiver decision was immediate and far-reaching. Oil traders, many of which had expected an environment characterized by tight supply (due to the boycott), were now facing a situation in which production greatly outweighed demand.
As a result of the saturation in the marketplace, prices experienced a violent and rapid decline - dropping from as high as $75/barrel in October of 2018 to as low as $42/barrel in December 2018. A stunning turn of events, relative to expectations.
Further complicating the situation was the fact that global equities were simultaneously in freefall (related to global economic growth concerns), which undoubtedly exacerbated the selloff in the energy sector.
As it turns out, that was just the first loop in the rollercoaster - there were more to come.
As of May 2019, crude oil is once again barreling down the tracks. But this time in the opposite direction. Since hitting the low $40s/barrel in December, oil has spent most of 2019 in "rally mode," and is now back above $60/barrel.
Interestingly, the catalyst for fresh volatility in crude oil is once again related to the Iran oil boycott, and associated "waivers." Toward the end of April 2019, the United States announced that previous waivers issued for the purchase of Iranian oil would not be extended past May 2019.
Basically, the shortage in supply that was expected in Fall of 2018 (and never materialized) is now back in play. While some of the biggest customers of Iran (China, India, and Turkey) have voiced concerns that they don't have enough time to switch to a new supplier by that deadline, the US appears steadfast in its decision.
The bull run in oil has been further supported by geopolitical concerns in Libya and Venezuela - two other countries that have historically supplied large quantities of oil to the international market. Domestic issues in both countries have limited production and hindered exports.
The emergence of price volatility often opens up potential trading opportunities and the situation with crude oil in spring of 2019 is no different. That's one reason the Options Jive team elected to unveil new research focusing on this commodity in a new episode titled "Trading Crude Stocks Against Crude Oil."
One of the most important developments identified in the episode is the high degree that crude oil (the commodity) has outperformed crude oil-related stocks thus far in 2019. The two graphics below highlight this situation quite vividly:
While both of the above graphics provide interesting insights into the energy market, the second slide is of particular interest. Looking more closely at the price chart, one can see clearly that the XLE (one of the best known oil-focused ETFs) is underperforming crude oil thus far in 2019 - one of the few times this has occurred since 2016.
This data illustrates that while oil itself has increased in value during 2019, the companies involved in this industry haven’t benefited from the same degree of optimism. However, that discrepancy may not last much longer.
At the end of April, Chevron (CVX) launched a bid to purchase Anadarko Petroleum (APC) for approximately $33 billion - catalyzing a 32% jump in the value of APC stock from the close of April 11th to the close of April 12th. One could argue that move is a fairly strong indicator that someone thinks oil stocks are undervalued, especially vis-a-vis crude oil.
As if that wasn’t enough, Occidental Petroleum (OXY) stepped in with a sweeter bid, offering $38 billion for APC only two weeks later. The bidding war pushed APC shares up another 17% into the first day of May (and up 55% overall since Chevron’s original bid was announced).
While each and every investor evaluates the relative attractiveness of opportunities in the market according to their own strategic approach and risk profile, current developments in the energy sector suggest that the energy sector may deserve a closer look.
On the aforementioned episode of Options Jive, the hosts outline a sample trade involving crude oil futures and crude oil stocks/ETFs that may help traders brainstorm on an approach that fits their own portfolios.
Liz and Jenny also talk about oil trading ideas on a recent installment of IRA Options, for those that may be interested in exploring the topic further. We hope you’ll take the time to review both episodes when your schedule allows.
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.