There's often hyperbole about market events being unprecedented. But the collapse in US crude oil prices to negative levels on Monday (April 20) truly was just that.
The value of a barrel of West Texas Intermediate crude oil dropped into negative territory, at one point it dipped below a negative $35 a barrel. While the price quickly recovered it only did so very low historical rates; a barrel of WTI crude oil was trading at only $13.87 per barrel in the morning of Wednesday in the US (April 22).
The severity of the price spike downwards was mostly a result of a precipitous collapse in demand as global lockdowns led people to stop driving and cities to consume less energy. Added to that, the supply of oil has greatly increased in recent weeks following the breakdown in an agreement between members of the Opec cartel led by Saudi Arabia and Russia. Crashing demand and surging supply made for an unpalatable mix for the value of US crude.
While it appears unlikely the price of oil will remain at such low levels for long, the ongoing impact of efforts to mitigate the spread of the coronavirus means there is little momentum for it to quickly rise either. And ultra-low oil prices have many effects, from cutting the energy cost of countries that need to import large quantities to reducing revenues of companies and nations that are heavy exporters of energy. It adds yet another factor of uncertainty into already volatile global financial markets.
We asked five experts how institutional investors should best navigate the fallout of such rock-bottom oil prices, and whether now is a good time to get exposure to the commodity.
The following remarks have been edited for brevity and clarity.
Daniel Gerard, senior multi asset strategist
State Street Global Markets
Typically energy price shocks come from either a demand shock or a supply shock. What makes our current environment unique is that the recent drop in energy prices is due to dynamics on both supply and demand simultaneously. Not only is demand temporarily inelastic, but when demand returns, inventories and sidelined supply will rush to meet it keeping prices low into 2021.
Oil prices are as geo-politically driven as they are market driven and interventions on behalf of suppliers is likely. For those long-term investors who have been looking to divest from carbon, our current situation provides an opportunity. Some energy companies may now look unattractive not only an ESG metric, but also a fundamental metric.
Our work has shown that in much of the world, the premium paid for the carbon factor has been coming down for a decade. This partially reversed in the US with looser regulation, however current dynamics and profitability should mean lower valuations are a trend in the US as well.
Tai Hui, chief Asia market strategist
JP Morgan Asset Management
Among a number of different asset classes, emerging market fixed income is one area that will require active management by Asian institutional investors. Oil and commodity exporters are likely to face pressure both on their exports and government fiscal revenue on the back of the decline in energy prices.
This would include economies in Latin America, the Middle East and Russia. Many of these economies are dependent on oil prices being at $50 per barrel or above to achieve a balanced government budget. This breakeven price could be higher, given the recent agreement to cut oil production volume.
The battle against the coronavirus outbreak adds to their challenge in supporting the economy in the near term. In contrast, Asia has a number of energy importers that would see lower import bills from cheaper oil. South Korea, China and India are all net oil importers. In particular, India should get some relief on its current account deficit from lower energy bills.
This would allow for the central banks to focus more of their monetary policy on boosting growth, rather than preventing excessive currency depreciation or capital outflows
David Chao, global market strategist, Asia Pacific ex-Japan
From an asset allocation point of view, we are recommending a barbell portfolio in the face of continuing economic uncertainty due to the Covid-19 lockdowns. At the one end we recommend defensive assets and on the other end we recommend cyclical assets such as real estate and industrial commodities, like oil. Equities have already gone up significantly in price and are no longer appealing.
Oil is interesting because it’s at a historical low. From our analysis, we think that further downside to oil prices is limited – and I am fairly confident that in 12 months’ time, oil prices will be higher than where it is now.
Firstly, OPEC and Russia agreed to cut supply starting in May and I think US shale producers will follow suit. The market is also well aware of the lack of storage facilities on the market. Secondly, on the demand side, around two-thirds of oil demand is driven by transportation of all kinds – getting the world back to moving again will certainly help buoy oil prices.
What happens next is also quite obvious: with reduced supply, when the global economy returns to “normal” there will eventually be a shortage of oil and a big rebound in prices – at some stage. This is already priced into futures contracts, which remain elevated compared to spot. When oil will stage a rebound, is less clear although I don’t expect it to come anytime soon.
James Trafford, analyst and portfolio manager
The plunge in oil prices on April 20 was both fascinating and unprecedented. US benchmark futures prices for West Texas Intermediate (WTI) dropped to negative $37.63 a barrel before recovering.
In effect there were no buyers for WTI physical delivery in May because there is scant demand, refining runs are being cut, and storage at Cushing, Oklahoma has grown to more than 15 million barrels in the past month – and is expected to soon be at capacity for the first time ever.
But while near term demand is very weak it isn’t cataclysmic. For example Brent crude, the international benchmark that is less tied to US consumption, did not see the same price action (and the front month is still around $25 as of writing on April 21).
That said, given the global demand shocks stemming from the Covid-19 outbreak, I expect oil prices and associated equities in the sector to remain broadly weak over the near term. The supply cuts that were recently agreed by the OPEC+ group of oil producing economies are not likely to be sufficient to balance the market soon.
Over the medium term oil price gains will be capped as accumulated storage must be unwound, spare capacity must come back online, and the oil-intensity of the economy probably settles below pre-crisis levels.
Colin Harte, strategist and multi-asset quant solutions portfolio manager
BNP Paribas Asset Management
Briefly negative oil prices resulted from a combination of unique technical factors and general supply/demand imbalances. Many speculative holders have now been shaken out.
Together with the likelihood of more defaults among US shale producers, this should help avert another extreme event when futures contracts are rolled again. While prices may remain under pressure in the short term, they probably won’t go negative again.
Yet the oil industry still faces oversupply and, most crucially, collapsing demand due to falling GDP. If economies move out of lockdown by June and activity recovers over the third and fourth quarters and remains solid through 2021, demand will pick up materially and prices should trade at $30 to $40 a barrel over the next 12 to 24 months. But longer-term environmental pressures and the growing efficiency of alternative energy sources will limit the upside in prices.
Asset owners have to consider their exposure to the oil sector and the potential benefits of lower oil prices to the broader economy. Clearly the oil sector will go through a period of consolidation and restrictions that can be exploited, particularly if our medium-term view on oil prices is correct.
Lower energy prices should help underpin the economic recovery as we come out of lockdown. While the broader global recovery may look broadly ‘U’ shaped, aggressive monetary and fiscal stimulus may lead to a very strong reflationary environment over 2021 that is positive for a wide range of commodities as well as oil.
This article was updated to clarify that James Trafford works for Fidelity International, not Fidelity Investments.