Regardless of the nature of a news event, prices in the financial markets will respond to expectations of how the future will play out differently than previously anticipated.  Investors will either seek to profit or protect against a loss.  We want to look at one aspect of the potential consequences of the BP oil spill, at what may have appeared at the time to be a “no-brainer” profit opportunity.

The matter at hand is the price of oil.  Within days after the April 20 accident on the Deepwater Horizon rig, you could have logically concluded that one result would be a restriction in oil supplies.  You might have anticipated that political support for offshore drilling would falter and additional regulations would raise the costs of drilling.  Indeed, a 6-month moratorium was placed on deepwater drilling applications shortly after (then overturned by a judge, but expected to be appealed).  Further regulation seems inevitable, even if the details are not yet clear.  The expectation would be that the additional costs to oil drillers will cause them to eventually cut back on some production that was only marginally profitable.  All in all, a strong case could be made that oil supplies would fall in the near future, pushing oil prices higher.  We don’t see any obvious flaws in this thinking.

Don’t you just wish it were that easy, though?  Regardless of the appealing case made above, the price per barrel of West Texas Intermediate Crude oil declined from $83.45 on April 20 to as low as $68.01 on May 20, before beginning to recover.  In that first month after the spill, not only did the compelling logic fail to push oil prices higher, they actually declined as much as -18.5%!  Had you made an investment based on the assumption that oil prices would have to rise, you are probably regretting it by now.
 

What went wrong?  Well, it just so happens that concerns about the European economy were rising during this same period.  As investors began to factor in a slower global economy, their projections for oil demand were lowered.  Less demand leads to lower prices.

So back to our initial question, was there a no-brainer opportunity as a result of the oil spill?  It sure looked like it, but it certainly hasn’t played out very well so far.  Maybe it turns out okay given more time.  But maybe not.

Our point in all this is that sometimes the case for or against an investment can seem so obvious.  Yet, the financial markets have a tendency to make even our most confident predictions look foolish at times.  Our view is that it is typically a fruitless endeavor for most investors to try to outsmart the markets and move in and out of different positions based on what they think will happen.  Better to build an investment portfolio that stands a chance of growing regardless of which way the market winds are blowing, even if the market price changes don’t always make sense to you.

Modus Advisors has no opinion on the prices of BP securities, WTI crude oil, or any related investments.  None of the comments above should be considered recommendations to buy or sell any investment.