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What are the options for trading on oil price volatility?

CMC Markets

For the last 50 years, oil prices and the oil and gas sector have been driven by the decisions of a large cartel of countries called Opec, which has striven to fix prices at a level that is bearable to consumers, while generating a decent return for producers.

This uneasy relationship between some very disparate West African and Middle East countries has generated significant tensions, as well as price swings, as the geopolitics between the bigger players results in power struggles for market share. Latterly, the US has become much more of a swing producer with its shale industry, upsetting what was until recently a fairly symbiotic relationship with Saudi Arabia, and to a lesser extent Russia, which is not a member of Opec.

Oil price volatility

This deterioration in the relationships between the bigger players has resulted in some of the more recent volatility in the oil market, particularly in terms of the recent sharp declines in prices, which while good news for the consumer, has also resulted in sharp declines in profits for the all the major oil companies, and the oilfield services companies that support them.

As such we've seen the sector undergo varying degrees of fortune since the financial crisis of 2008, with oil prices ranging from peaks above $140 a barrel for Brent crude, to lows in US oil prices of -$40 a barrel. That’s right, at one point during 2020, US crude oil prices fell into negative territory, something that had previously been thought of as being implausible. Faced with the prospect of too much oil supply and nowhere to store it, some US crude oil futures contract holders paid someone else to take it off their hands.

When oil prices first came crashing off in 2008, falling over $100 a barrel between the months of July and December of that year, many in the industry were predicting that the global economy was in danger of reaching peak oil. Since then however, we’ve seen the price of black gold, as it is sometimes known, trade as high as $115 a barrel before once again coming crashing back down just as abruptly.

This volatility makes it very attractive to experienced short-term speculators, however as far as longer-term investors are concerned, the sharpness of the moves can make it quite tricky to harness as an investment opportunity, or even try and hedge against specific moves. To combat this volatility, as well as helping investors to diversify and hedge their risk, market makers have come up with various ways to gain broad exposure to the sector, without putting all their eggs in one single basket, or one particular company.

Introducing the Gas & Oil share basket

CMC Markets' new Gas & Oil share basket offers the opportunity to diversify your trading and take a position on 10 US oil and gas stocks with a single trade. This means it’s more cost-effective than spreading risk across a number of individual stocks, but also reduces the overall impact if one particular stock runs into problems, prompting a sudden share price drop.

Share baskets present the chance to gain exposure to trending industry themes. You can spread bet or trade CFDs on share baskets with no commission, and 50% lower holdings costs versus trading on individual shares.

Gas & Oil basket components

Components in this new basket, each with a 10% weighting, are: Exxon Mobil, Chevron, ConocoPhillips, Kinder Morgan, Phillips 66, EOG Resources, Valero Energy, Schlumberger NV, Baker Hughes and Pioneer Natural Resources.

A lot of the bigger oil majors like Exxon Mobil, Chevron and ConocoPhillips, tend to attract large investor interest due to their ability to pay attractive dividends, and in recent years have also paid out decent amounts in the form of share buybacks.

For example, Exxon Mobil, spent over $210bn in the 10 years leading up to 2016 buying back its own shares, until the oil price crash of late 2015 forced it to conserve cash to bolster its balance sheet, sending its share price sharply lower by about 30%. This type of move at any time would be painful for shareholders, however in recent years it’s been more or less par for the course for oil and gas stocks, as they move to the ebb and flow of energy prices, as well as geopolitics.

In order to hedge against these types of moves and spread risk, as well as avoid the various transaction fees involved in trading in and out of the market, a variety of different instruments have been designed in the last few years to help keep transaction costs down as well as hedge against this sort of price volatility, with a raft of different ETFs of varying degrees of complexity.

Some ETFs like the US Oil fund (USO) track the moves of US crude prices across, and had until recently tended to be heavily weighted towards the front month, making it hugely price sensitive to short-term moves. Other ETFs like the SPDR S&P Oil and Gas Exploration ETF have a much broader range of holdings, from the small US shale producers to the big oil majors like Exxon Mobil. This makes them much less susceptible to a big move in one particular company’s share price. On the downside it also means that any prospect of large-scale bankruptcies in the sector means the ETF could be susceptible to even bigger price moves, given it has holdings of over 50 different companies within it, some of whom may not be particularly liquid.

The use of ETFs or share baskets allows investors to avail themselves of the ability to diversify their risk across a range of different stocks. As such they can be one of the most powerful risk-management tools available to investors, but they can also be very risky products for the unwary.

You can choose to spread risk across a number of stocks reducing the overall impact if one of them fails, or you can invest in a smaller number of well-established and larger companies, like the 10 stocks in our US Oil & Gas basket.

 

Leveraged ETFs are complex financial instruments that carry significant risks. Certain leveraged ETFs are only considered appropriate for experienced traders.


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