Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.
These are undoubtedly among the worst of times for oil investors. On Monday, the price of one grade of Texas crude for delivery in May turned negative under a sea of US inventories1. Oil prices elsewhere around the world also fell, though not to the extent seen in Texas. Brent crude, for example, temporarily slid to its lowest levels since 1999, to around US$16 per barrel2.
We’ve not seen anything quite like this since the Great Depression of the 1930s, when the price of oil plunged to 15 cents per barrel in 1931 and to just 10 cents two years later3. With the demand for oil under lockdown conditions in the US now tumbling, the stocks of crude held at refineries and tank farms have been filling rapidly4.
The problem is symptomatic of falling demand during the worldwide lockdown, but the brief appearance of negative oil prices in Texas reflects particular supply and demand issues in America. Monday was the last day holders of contracts to receive oil supplies in May could sell and avoid being forced to accept physical deliveries they had no capacity for.
This could be seen as an accident that was waiting to happen. Thanks to its increasingly productive shale fields, the US has become the world’s largest oil producer, surpassing Saudi Arabia and Russia in 20195.
At the same time, the US has taken the biggest economic hit from the coronavirus. With the largest death toll in the world and job losses since the economic shutdown began now topping 26 million, the demand for oil from the world’s largest economy has plunged6.
Oil bounced back modestly towards the end of this week, however, the big question now is can it return to its previous levels of around US$60 to US$70 per barrel once the coronavirus threat has passed, or only a level substantially below that?
There are two main possibilities. The first is the demand for oil rebounds as might be expected in the wake of a global crisis. Prices will rise as transport gets back to normal and consumers return to their cars.
Low prices will initially spur a lack of frugality leading to more oil being used up. People may decide to use their cars more often than before, if only to avoid being in close proximity to others on planes, on public transport or even in the streets.
The low current price of oil will cause some US producers to shut down, which is relatively easy to do given the particular way shale oil and gas is pumped. Meanwhile, Saudi Arabia and Russia – which ill-advisedly embarked on a brief but costly price war in March – may cut production to levels more in keeping with the global loss in demand.
The second possibility is that there is a more permanent shift away from the use of fossil fuels now that the world has gotten used to using them less. It seems likely that the tourism industry for one will be running well below full capacity until a vaccine for the coronavirus can be found.
Whichever of these scenarios eventually prevails, it seems likely that oil prices will remain under considerable pressure until the coronavirus threat has passed, and that might not be for some time yet.
In the meantime, and with the strain on storage facilities in America unlikely to dissipate quickly, it’s hard to believe the expiries of Texas oil contracts in June and July will be trouble free.
For investors, low oil prices will have mixed effects, both welcome and not so welcome. The positive side of the equation relates to businesses and consumers having more cash left over to invest and spend once economies start to return to normal.
Low oil prices are normally a tailwind to consumption growth, with benefits for retailers, transport companies and leisure businesses alongside others. However, these industries will only really benefit once consumers have exited lockdown conditions.
Oil producers, oil services companies and businesses operating in the electric vehicle and renewable energy industries could be the principal losers. Parts of the US where the oil industry is a major employer – Texas and North Dakota – along with Russia and the Middle East are also set to lose out.
In relation to renewables, the near term outlook lies in the balance. Low fossil fuel prices and high levels of government debt after fighting the coronavirus count against the installation of new wind, solar and hydroelectric facilities.
The industry may require a concerted push to force climate change back up the international agenda post coronavirus. Politicians face two choices: either to rebuild the old fossil fuel world as quickly as possible; or to capitalise on disconnects in the global economy to accelerate the energy transition. Only time will tell which it will be.
Under current conditions, the best step investors can take is to ensure their investments are diversified. Actively managed funds will be in a position to sidestep the worst effects of a low oil price while capitalising on the opportunities that emerge because of it.
Of particular interest in the UK, particularly to equity income investors, will be how Britain’s oil majors respond to the price crash. BP and Shell account for a sizeable part of the stock market and the dividends paid out to UK investors each year. Both will want to protect their excellent long term records of maintaining or growing their dividends year on year, but the present environment poses an immense challenge.
Alongside time, diversification is, perhaps, the most valuable weapon investors have. Options for further diversification beyond that offered by a UK equity income fund include investing in a global income fund – such as the Fidelity Global Dividend Fund – or a fund able to access an income return from corporate and government bonds – such as the Jupiter Strategic Bond Fund. Both funds feature on Fidelity’s Select 50 list.
Five year performance
|(%) As at 31 March||2015-2016||2016-2017||2017-2018||2018-2019||2019-2020|
|Brent Crude Oil||-27.9||33.8||32.6||-1.6||-78.1|
Past performance is not a reliable indicator of future returns
Source: Refinitiv, as at 31.3.20, total returns in local currency
1 FT, 22.04.20
2 Reuters, 22.04.20
3 Effects of Foreign Oil Imports on Independent Domestic Producers, United States Congress House Select Committee on Small Business, 1949
4 Reuters, 20.04.20
5 EIA, 01.04.20
6 Department of Labor, 23.04.20
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.
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