There's So Much Pessimism In Oil

*This is not financial advice. All content should be considered opinionated. We are not responsible for any of your gains and losses. I am neither a licensed or registered financial expert. Please see a financial advisor before making investment decisions.

Photo by Zbynek Burival on Unsplash

With oil futures selling off severely to where the price of oil went to $20 a barrel and lately $15 a barrel, the oil sector as seen a huge beating. This type of beating can be compared to the beating financial stocks received during the financial crisis as many people feared that many banks were going bankrupt.

The pessimism that investors have for oil can be traced to business activity plummeting as well as the increasing concern for the storage of oil with many oil storage facilities being filled with oil. With oil hitting $15 during the time of writing, all this pessimism that I'm seeing in the oil fields is starting to make me intrigued in the sector. Could this be time to buy the dip in oil stocks?

While many are worried about decreasing demand and increasing supply, at the end of the day, oil is a nonrenewable resource

Oil is a fossil fuel. To make oil, we'll need decaying organisms to be placed in intense pressure for years (or even centuries), making this resource hardly renewable. The amount of oil we use today is still large as its the main fuel for transportation and is used for creating many other things like plastics, medical supplies, and chemicals. Oil is essentially a limited commodity that is vital to the economy. 

Also, while renewables are slowly starting to replace petroleum in providing energy to the world, the main issue with renewable energy is storage. Storage for electricity is expensive. Lithium-ion battery technology is still in its infancy and the energy density of those batteries is still small compared to oil. The lithium-ion battery issue is what's holding back the major scale production of wind farms and solar farms in places where they can provide a lot more energy. 

With the recent truce between OPEC and Russia and economies opening up in the future, the massive surplus of oil will be temporary

In the meantime, many nations are calling for massive production cuts for drillers. In the US, governments are debating whether to provide a financial incentive for shale drillers to cut back on production in order to alleviate the massive surplus in oil. Other nations are also telling their oil producers to cut back on production. 

In addition, with governments looking to open up the economy by summer or later, the demand for oil will rapidly increase as more people will commute to work, factories will resume production, etc. If oil futures were trading at $40-$50 a barrel, then with oil at $15 during these hard times, those who are holding the commodity itself are looking at doubling or even tripling their investment. By the way, that trade will be really risky. 

In the meantime, the refiners will benefit tremendously

Because refiners rely on the price of oil to determine their profits, with low oil prices, many refiners are looking at much lower raw material costs. The massive reduction in raw material costs increases margins for refiners. If I were an oil refiner, I'd accumulate as much oil as possible in these levels and horde them. That way, once the economy reopens, I'll continue to have higher profits. 

Overall

With the extreme pessimism taking place in the energy sector, now might be a great time to be contrarian. Since oil is a limited resource and the forces that cause oil prices to plummet are temporary, there is hope that oil prices could rebound. In the meantime, be careful with the oil sector and watch out for the many drillers that could go bankrupt or near bankruptcy.