A quick trip on the weekend down to Coffs Harbour from sunny Queensland saw me paying $1.50 per litre for premium unleaded fuel. While my modern sports car barely gets a run once a week, resulting in a monthly visit to the petrol station, I was perplexed by the disparity between current global crude oil prices and the price I was paying at the pump. Discussions with clients since have reflected a very similar opinion.
Let’s just take a look at where crude oil is currently trading. At time of writing, Crude was trading at $46.04 a barrel. Now that price is after a hefty rally on Wednesday following the US Federal Reserves FOMC statement which resulted in the US Dollar plummeting. This triggered a rally in Crude, Gold, and almost all other commodities as well.
Crude had hit a long-term low of $42.41 on Tuesday the 17th March – St Patricks day. Compared to the consumption of green ale at your local Irish pub, the decline in crude since June last year is far more impressive. Peaking at $107.68 on the 13th June 2014, it has declined more than 60% to the recent low.
Why am I still paying $1.50 a litre – a mere $0.15 to $0.25 lower than a year ago?
The Australian Institute of Petroleum (AIP) states that “crude oil pricing benchmarks for the Asia-Pacific market including Australia are Tapis, Dated Brent and Dubai – not West Texas Intermediate (the US crude oil benchmark).
Ok, so we need to stop looking at WTI (Crude Oil) and start looking at Brent. While Brent trades at a higher price, at time of writing it was $55.91 a barrel, it mimics the activity of Crude. Not exactly, but certainly in the same trending fashion.
So again, why are we paying such high prices?
For the US, which has become a net exporter of Crude over the last two years, the first time in their history, fuel is cheaper than other countries. Taxes in Europe and Australia, for example, have kept prices higher compared to the US, despite the commodity halving in value.
Around 20% of Australia’s petrol is imported (mostly from Singapore and South Korea). Clearly, there is a premium due to transportation costs and a commercial incentive for the importer. Then we have to add on the transportation costs within the country, and of course the commercial incentive of the petrol station as well.
The AIP states that there is a short time lag of 1-2 weeks between changes in Singapore prices and the changes in Australian wholesale prices. Yet, even their data shows that wholesale prices have declined since June 2014. If I go back to Crude/Brent prices 2 weeks ago they rallied to $51/$61 a barrel respectively. That’s still well below last Junes prices, and I’m still paying $1.50 per share at the pump. It’s criminal!
Surely if the cost of the product at a wholesale level is much cheaper, even despite the additional costs of tax and transportation that we have to pay here in Australia (don’t forget that it’s only 20% of our petrol that is imported through Singapore and South Korea), then why are we paying so much at the pump?
The geopolitical picture doesn’t paint a better picture
The world doesn’t need Crude oil as much as it used to. Not by amount of consumption, but in terms of demand. Renewable energy, more efficient motorcar engines, and electric vehicles have stretched the ‘Peak Oil’ forecast for when the world will run out of oil. At the same time, with new technology in shale oil extraction, current production levels are at record highs, giving us a supply/demand balance that would normally suggest lower prices. What this means is that the world is becoming less fuel-intensive.
OPEC (Organisation of Petroleum Exporting Countries) has stated they will keep crude production levels high. This is the kicker for why crude/brent has fallen so heavily. Normally OPEC would reduce production levels to maintain a key global price level. Yet they have purposely maintained high production levels in a fight against the US and Russia (who is at war with the Ukraine over facilities to export crude and natural gas).
So how does that affect us?
Despite US onshore rigs being cut at an alarming rate, approximately 684 over the last 12-months (down nearly 38%), and widespread capital expenditure reduction mostly through cutting of staff, data produced by Energy specialist Wood MacKenzie suggests 1.6% of the world’s supply would be operating on a cash-negative basis if Crude were at $40 per barrel. Another study suggested 47% of US oil production could breakeven if WTI was at $61 per barrel.
So at the current prices, quite a large number of Crude producers are operating below costs! That is, they are losing money. And OPEC countries in particular, such as Saudi Arabia, Iraq, Iran, Kuwait, Venezuela, Qatar, and Indonesia (amongst others), will be feeling the pinch pretty soon.
If production levels remain as they are, in particular from OPEC as the US will start showing a decrease in supply soon due to the number of Rigs closing down, then Crude/Brent prices are going to fall. Some analysts are already expecting a drop down towards $40 a barrel.
But how do you play this in the markets?
With an expectation that Crude/Brent will fall, you could trade a short position on the physical commodity futures contracts. Sell the rallies, and buy on the dips.
Alternatively, United States Oil Fund LP (USO) is a listed stock in the US that trades crude oil. It is what is known as an Exchange Traded Fund (ETF), and can provide exposure to the commodity without buying the physical. It has options traded against it, so you can purchase Put options to benefit from a decline in stock price (following crude). Otherwise, there are various option spread strategies that can be adopted as well.
There is a reverse ETF for Crude oil, code: SCO. This is the ProShares UltraShort Bloomberg Crude Oil ETF. Basically, this stock will rise in value when Crude oil falls, and fall in value when Crude oil rises. It too has options traded against it.
If you’re afraid that the prices at the pump are not going to fall, then you could take a position shorting crude, in any of the above scenarios, and if it falls and you make a profit from that movement, you have offset the higher cost you have paid at the pump. Of course, if prices at the pump actually fall as well, you are literally double dipping!
There are numerous ways in which you can ‘hedge’ or play a potential fall in crude prices. If you would like to learn more, contact our brokers for more information by clicking here.
I, for one, am hoping that this will reflect in a drop at the pump. We came close to seeing premium unleaded at $1.10 per litre earlier in the year, and with Crude/Brent at long-term lows, I’d expect in the next couple of weeks we will see a fall towards that price again. Should we see that, I’ll definitely be getting the MG out of the garage for some additional driving time.