The $9 Million Mistake

Syed Shah had a plan. On April 20, 2020 the 30-year old from Toronto decided to take his $77,000 account and trade oil futures. In a few hours, he lost $9 million.

It was innocent at first. With a price of $3.30 per barrel at the time of his first trade, Shah dove in buying an initial five contracts. He added 21 more as the price moved lower. In total, he scooped up $2,400 worth of oil futures in 40 minutes. 

Finally, when the price flashed one penny, he went all in snapping up another 212 contracts. Feeling confident, he shut off his screens and went about his day.

The problem was the price of oil kept slipping. It went to minus $1, then minus $10, eventually settling at negative $37.63 by the close of trading.

Shah started panicking. He didn’t think the price of oil could go negative. He froze with fear.

Finally at midnight, he got a call from his broker. What started as $77,000 in his account ended with Shah $9 million in debt. It was devastating.

Shah thought he was getting the deal of a lifetime. Instead, he traded his account into oblivion.

Luckily for Shah, his broker made the decision to make traders like him whole. They would refund any amount lost below a price of $0. So while he didn’t end up owing $9 million, he still lost it all.

What Shah failed to understand as a novice was just how the oil contracts he was trading worked. Trading oil futures in the U.S. typically means trading West Texas Intermediate (WTI) crude oil.

Internationally, many non-U.S. traders tend to trade Brent crude oil contracts.

But the difference is with Brent, you don’t have to take delivery of the oil underlying the futures contract. With WTI, you do.

That’s why the price of oil turned negative that day. Traders holding contracts rushed for the exits to avoid having to take physical delivery of oil. That much pressure on the market also meant they were willing to pay other people for the privilege of taking the contract off their hands.

I can almost guarantee that Shah had zero knowledge of that fact. Or what was driving the price lower and lower to begin with.

But while that period of the price of oil diving below zero is long gone, the thought that novice traders can outsmart the oil market isn’t.

Trying to trade oil during any sort of geopolitical event is a surefire way to lose money. There’s no better example of that than the current war in Iran.

The last several weeks in the news cycle is all about Operation Epic Fury, the U.S. and Israel joint operation in Iran…and Iran’s response to it.

It all started on February 28 when U.S. and Israeli forces decimated Iran’s long-standing leadership. Iran’s response – or at least those scrambling to take charge – was basically “Let’s attack everyone.”

Israel, Saudi Arabia, Qatar, the UAE…no one was off limits.

Iran also declared it was closing the Strait of Hormuz.

The Strait of Hormuz connects the Persian Gulf with the Gulf of Oman, eventually leading out into the Indian Ocean. It’s 21 miles wide.

There are two shipping channels, each 2 miles across. They’re separated by a 2-mile buffer zone. Which makes it easy to patrol as a chokepoint.

It’s one of the key traffic points for shipping oil and gas around the world. About 20% of world oil shipments happen to pass through it.

But it’s not without risk. On one side sits Iran. On the other sits Iran’s ally, Oman.

Most of the traffic runs through Iranian territorial waters. Especially past the islands of Qeshm and Larak. Islands that have a heavy military presence.

For the most part, oil tankers have no issues traversing the Strait. According to the International Energy Agency (IEA), about 70% of oil shipments traversing the Strait head for Asia.

But when Iran announced it was “closing” the Strait, oil markets responded swiftly. Especially on March 8 and 9, when oil spiked about 30% overnight.

But by the end of the day the price of oil was practically unchanged.

It was one of the largest intraday moves in oil in history. And I can almost be certain there were plenty of Syed Shah’s who lost it all trying to play the game.

As a long-time trader and follower of the oil markets, I know it’s always good practice to ask questions before jumping into a trade for fear of missing out. In this case: who benefits?

In reality, Iran’s energy economy depends on allowing its oil and gas to leave its ports and head to their final destination. The same goes for its ally in Oman. And pretty much every other country in the region.

One of its largest trading partners just happens to be China. Fully 90% of Iran’s total oil exports end up in China. And China sources about 40% of its crude oil imports from the region.

India is another large importer with about 42% of its oil coming through the Strait. They’re not the only ones.

But more than that, other exporting nations – namely Saudi Arabia, the UAE and Iraq – depend on their oil shipping through the Strait…at least for now.

So who benefits from the closing of the Strait of Hormuz? Almost no one, except producers from outside the region. And especially not countries that rely on oil and gas from the region for their energy needs.

I would argue “closing” the Strait is more detrimental to Iran than anything else. Something that’s already starting to play out in real time.

It’s angering the Gulf States, including Qatar, the world’s second largest exporter of liquefied natural gas just behind the U.S.

Iran isn’t just trying to block Qatar from shipping. It actively bombed Qatari natural gas infrastructure. So much so, that after a recent strike on the Ras Laffan refinery – the world’s largest liquefied natural gas (LNG) facility – Qatar immediately expelled Iranian diplomats from the country.

Those strikes took about 17% of Qatar’s capacity offline. And QatarEnergy CEO Saad al-Kaabi said it may take up to five years to get it back.

That’s especially bad news for Europe, which relies on Qatari LNG after it effectively stopped importing natural gas from Russia. (Something I discussed in in the March issue of Strategic Trader, recommending a way to play that trend with a new warrant pick. And in just one week, we’re sitting on gains of 138%.)

Yet what’s interesting today is the oil market is fracturing.

What I mean by this is by looking at the different prices of oil itself.

When you see a quote of the oil price it’s usually for WTI or Brent crude. These are two of the most common types of oil produced. They’re lighter varieties mostly produced on land. The crude oil pulled offshore out of the U.S. Gulf is heavier.

But what you may not realize is not all oil is the same. There are upwards of 160 different varieties of oil.

Refiners need heavy oil to mix with lighter WTI and Brent. The combination produces medium-weight crude which many U.S. refineries require.

Then they can produce the types of products – gasoline, kerosene and other chemicals – that we ultimately use. Like the asphalt we drive on. And even the pharmaceuticals you may take on a daily basis.

And before this war started, WTI and Brent typically traded within a tight range of one another.

But now we’re seeing that link fracture. The spread is blowing out. And we’re even getting a third variety – Dubai crude – come into the picture.

What does this mean? It means that the oil market is separating geographically. Where price may depend on what region of the world you’re in rather than the makeup of that crude.

In a world where energy independence means energy security, it’s the exporters of oil and gas that will ultimately benefit the most.

That includes the U.S., the world’s largest producer of oil and gas today.

When it comes to oil, sometimes it pays to just sit back and wait for a clear trend. Especially in the case of a geopolitical event. Rushing to speculate on its price because of some perceived outcome can wipe you out in a hurry. Just like it did to Syed Shah.

So instead of speculating on an uncertain outcome, sit back, be patient and look for other ways to play it. Like the warrants I recommend to Premium readers of Strategic Trader. Something I’ll go into more detail next week.

After all, it may just save you $9 million.

Regards,

Editor, Strategic Trader