For most people, the idea of looking back on the last year is probably not that appealing. The phrase "because, you know, 2020…" has become a punchline, and for good reason. This year will forever be remembered as the year that Covid-19 arrived, killing hundreds of thousands of Americans and over 1.5 million people worldwide. With that tragedy came the attempts to limit the carnage, at least for a while, businesses closed, and people stayed at home, resulting in the largest single-quarter drop in GDP ever, massive job losses and devastation for small businesses.
Still, looking back is what most people, and especially traders, do at this time of year. We learn from our mistakes, resolve to repeat our successes, and make educated guesses as to what we can expect next year.
From an energy trading and investing perspective, 2020 was a historic year. It started well enough, with WTI trading above $60, then the decline began. It was so big and so fast that in April, for the first time ever in the long history of oil futures trading, a contract went negative. For a short time, rather than paying for crude, you got paid up to $37 a barrel for taking it as a contract expired. Even for delivery a month out, WTI traded as low as $6.50 per barrel... That was the result of a "perfect storm" of epic proportions.
U.S. output, encouraged by a White House that seemed intent on repealing every regulation on the oil industry, passing every pipeline project, and…
For most people, the idea of looking back on the last year is probably not that appealing. The phrase "because, you know, 2020…" has become a punchline, and for good reason. This year will forever be remembered as the year that Covid-19 arrived, killing hundreds of thousands of Americans and over 1.5 million people worldwide. With that tragedy came the attempts to limit the carnage, at least for a while, businesses closed, and people stayed at home, resulting in the largest single-quarter drop in GDP ever, massive job losses and devastation for small businesses.
Still, looking back is what most people, and especially traders, do at this time of year. We learn from our mistakes, resolve to repeat our successes, and make educated guesses as to what we can expect next year.
From an energy trading and investing perspective, 2020 was a historic year. It started well enough, with WTI trading above $60, then the decline began. It was so big and so fast that in April, for the first time ever in the long history of oil futures trading, a contract went negative. For a short time, rather than paying for crude, you got paid up to $37 a barrel for taking it as a contract expired. Even for delivery a month out, WTI traded as low as $6.50 per barrel... That was the result of a "perfect storm" of epic proportions.
U.S. output, encouraged by a White House that seemed intent on repealing every regulation on the oil industry, passing every pipeline project, and opening up every acre of land and sea to drilling, had been soaring for a few years to record levels. There was a huge boom in the oil business. Then, that massive supply hit a sudden contraction in demand as the Covid restrictions were imposed. Nobody was driving, nobody was flying, businesses were shuttered. Before long, storage facilities filled up and that lack of space was the direct cause of negative WTI prices on the expiring contract.
In some ways, that is such an unusual confluence of events that there is not much to learn from it going forward, but there is one thing that it should make us realize…All that talk about how futures trading involves a high degree of risk is not just talk. When everyone is trying to trade in the same direction and liquidity effectively disappears, it can be pretty scary. The exchanges do have circuit breakers, but they kick in after a +/- 15% move in a 60-minute lookback. That is a big, rapid move, and suspending trading after that can, as we saw in April, actually increase, rather than reduce panic by removing liquidity.
None of that is a reason not to trade futures if you know what you are doing, but it is why I constantly bang on about the importance of discipline, taking profits, and sticking to stops, when I write on the subject. 2020 should reinforce the importance of that.
Of course, the market responded to all of that, as markets do. As the price fell out of bed, so the rig count began to plummet. After years of steadily increasing, U.S. production began to fall, until supply and demand were just about back in balance. That caused some major dislocation in the industry, with bankruptcies common, particularly among smaller E&P companies. As distressing as that was for many of those directly affected, that too is the market doing its thing and regulating supply.
As that happened, prices began to recover, and stock in those that survived bounced back rapidly. Energy investing became, for a while, like shooting fish in a barrel. You could buy stock in massive companies with virtually zero immediate risk of bankruptcy at low single-digit P/Es that, even after cutting dividends, still offered double-digit yields. Or, if you were happy with more risk, you could buy alternative energy stocks or smaller E&P companies and bank triple-digit returns.
As I said, the point of looking back is to learn, and there are two important lessons that underlay all that drama.
The first is that no matter how bad things may look in the short-term, there is still massive underlying demand for energy and the sector isn't going anywhere. There will be collapses again, for sure. When they come, remember that if you stick to solid names with little existential risk and as long as you are patient, they are opportunities more than anything.
The second is that, for all their imperfections, free markets work. They can be brutal at times, but they are the most efficient way of bringing supply and demand into balance and allocating resources where they can do the most good. Mess with them at your peril.
So, this is not a year when people will be looking back fondly. However, the calendar change will, as it always does, bring new hope. And in an energy industry that has been forced into a massive rationalization and realignment, that is itself a valuable commodity. Happy Holidays!