When entering the site and if cookies are prevented from being saved, a message must be displayed
in a popup message box informing the user that their local browser settings are preventing
cookies from being saved and that cookies are required for the site to work. Exact text
to be provided for UAT. On OK click of the message, the user should be redirected to
the global landing page (currently ssga.com).
On April 29, 2020, State Street Global Advisor investment experts Andrea Anastasio (Head of North America Investment Strategy & Research), John Campos (Senior Research Analyst, Global Fixed Income, Currency & Cash), Elliot Hentov (Head of Policy Research), Daniel Lavoie (Global Energy Analyst, Fundamental Growth & Core Equity), and Lisa O’Sullivan (Research Analyst, Fundamental Value Equity) shared their perspectives on the oil price collapse and the impact this crisis is having on investors.
Context in terms of prior oil market events, i.e., why this shock is so much faster and deeper.
Big price movements typically shift wealth from consumers to producers, or vice versa, but are relatively balanced macroeconomically. The current event is pure wealth destruction, as consumers cannot leverage low prices due to the lockdowns in place. This is bringing permanent damage to balance sheets as well as industry demand, even if all else stabilizes. The fallout from this oil shock will be with us for a while.
Effects of the oil shock beyond the energy sector.
All balance sheets are indirectly or directly linked to energy. US capex is likely to drop by 25-30% in the energy sector, so that will shrink demand for US manufacturing, which will have a weaker recovery than global manufacturing. The other challenge in the US will be to the financiers of the energy industry, given that defaults will likely rise as the industry consolidates.
In relative terms, which countries will be the winners and losers. The losers are likely to be oil producers across the board, particularly those with weak balance sheets, as well as those within the extended oil value chain. Ultimate winners are probably going to be the survivors, if large parts of the energy sector shut down. Marginal players are more at risk than key players (e.g., Saudi Arabia, Russia), which have low production costs and maximum scale that will enable them to weather the downturn and capture market share on the rebound.
How we got to $-37 oil, and whether we should expect to see more negative pricing.
That was a perfect storm. In typical times, there is always someone out there ready to buy the crude contract, typically a crude marketer or a refiner. What was interesting last week was that, given that storage was expected to be full, physical buyers did not show up, which led to a no-bids situation. The second contributor was that in the days/weeks prior to the contract rollover, there had been a big increase in oil ETF demand, prompting the ETF to purchase and support the spot oil price; they then had to sell those contracts to roll over into June contracts. We’re not expecting negative prices again.
The outlook for oil, including near-term and long-term prices.
This will be a challenging time for the oil market, especially within the next 2-3 months. We see an inventory overhang of 600-800 mmbbls end of June, which is close to tank top across the world. The real challenge is to quantify the structural impact of COVID-19 on long-term demand. We need three things in order to see >$45/bbl oil again: (1) market balance, (2) surplus inventories to normalize, and (3) full return of OPEC + production. We expect oil prices to remain depressed through July; assuming that economic activities return this summer, we could see more of a demand/supply balance and head toward ~$30/bbl by year-end.
How we should think about our investments across the energy sector.
There are very few winners, but the relative losers will be those with high levels of debt, high production costs, and inflexible capital expenditure commitments. Energy Equipment and Service companies have been the hardest hit in this crisis (and had already been suffering from overcapacity).
What to look at when evaluating these companies.
We are looking for those companies that are cheap when we take into account the current crisis as well as the impacts of the longer-term secular decline in energy driven by the energy transition and the move toward a lower-carbon future. Holdings must have the balance sheet and liquidity to withstand the current low prices and survive into the next stage of the cycle. They must also be attractively valued when factoring in the current headwinds facing the energy market. Valuation must compare favourably to intrinsic value when all negative factors are taken into account.
How bad the crisis will be for shale E&Ps.
Most shale producers require a significant amount of spending to maintain production. With capex in North America being down 40-50% post-Q1, expect a dramatic drop in oil output. Some producers are even shutting down volume. This implies production will naturally fall, likely by 15-20%, by December. Once things settle a bit, US shale producers will have less production than when the crisis started, and their ability to finance and grow will be impacted also. On the other hand, US natural gas prices could improve medium-term. With lower oil production, this could lead to a tighter market for natural gas.
The impact on credits.
While companies are responding to today’s crisis in a similar fashion to that of five years ago, generally their available options are fewer or less impactful. Going into this cycle, Integrateds and E&Ps were fairly lean, so there is simply less fat to cut. We now see 2020 capex falling roughly 24% to $140bn. Dissecting that, Integrated capex will be down roughly 16% while E&P spending will decline 43%. During the last cycle, E&Ps cut their dividends by 37% and Integrateds showed little movement. So dividends could be a source for needed cash flow flexibility for E&Ps, and some will act decisively.
The ability of companies to access the capital markets. Capital markets were incredibly accommodative to E&Ps last cycle, issuing roughly $30bn of equity to bolster balance sheets in 2015-2016. Of that amount, only ~$4bn was raised by Investment Grade-rated companies. The remainder was by High Yield E&Ps, and we just don’t see the equity markets stepping up again, except perhaps for the largest E&Ps. Also, we don’t believe the debt markets will be there to bridge either a cash flow gap or fund refinancing needs this cycle, again except for the strongest companies. We expect market access to remain challenged.
Other sources of liquidity that can be tapped.
Investment Grade E&Ps benefit from unsecured credit facilities and traditionally a maximum debt-to-capital covenant. Conversely, most High Yield E&P bank facilities are secured, with the borrowing capacity limited to the value of oil and gas reserves. Reserves are generally revalued in early spring and again in the fall. With today’s forward curve at $25-30/bbl, High Yield E&P borrowing capacity could be reduced by as much as 40-50% versus pre-crisis levels.
How we are investing given liquidity constraints.
We have stress-tested the sector across a variety of oil prices. Many E&Ps are well-hedged for 2020, which will soften the impact of today’s prices, but that is not the case for 2021. The crisis is exposing weak balance sheets, poor assets, and an external funding reliance. It’s critical to understand those companies that are most at risk as well as those for which opportunities may lie on the eventual upswing. It’s best to stay with solid balance sheets, strong liquidity profiles, and high-quality assets given all the uncertain outcomes before us.
The views expressed today are the views of the individual speakers and are subject to change based on market and other conditions. All information is provided in good faith, and there is no representation nor warranty that such statements are guarantees of any future performance. Actual results or developments may differ materially from the views expressed. SSGA Global Entities Link: https://www.ssga.com/global/en/our-insights/state-street-global-advisors-worldwide-entities.html
Investing involves risk including the risk of loss of principal.
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA's express written consent.
The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor. All material has been obtained from sources believed to be reliable. There is no representation or warranty as to the accuracy of the information and State Street shall have no liability for decisions based on such information.
The information contained in this communication is not a research recommendation or ‘investment research’ and is classified as a ‘Marketing Communication’ in accordance with the Markets in Financial Instruments Directive (2014/65/EU) or applicable Swiss regulation. This means that this marketing communication (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research (b) is not subject to any prohibition on dealing ahead of the dissemination of investment research.
SPDR ETF is the exchange traded funds ("ETF") platform of State Street Global Advisors and is comprised of funds that have been authorised by European regulatory authorities as open-ended UCITS investment companies. SPDR ETFs may not be available or suitable for you.
ETFs trade like stocks, are subject to investment risk, fluctuate in market value and may trade at prices above or below the ETFs net asset value. Brokerage commissions and ETF expenses will reduce returns.
Changes in exchange rates may have an adverse effect on the value, price or income of an investment. Further, there is no guarantee an ETF will achieve its investment objective.
SHARES IN THE FUNDS OF THE SPDR® ETF SICAV, SSGA SPDR ETFS EUROPE I AND SSGA SPDR ETFS EUROPE II PLC MAY NOT BE AVAILABLE FOR OR SUITABLE FOR YOU. THE VIEWS EXPRESSED IN THIS SITE DO NOT CONSTITUTE INVESTMENT ADVICE. INDEPENDENT ADVICE SHOULD BE SOUGHT IN CASES OF DOUBT. NEITHER THE INFORMATION NOR ANY OPINION CONTAINED ON THIS SITE CONSTITUTES A SOLICITATION OR OFFER TO BUY OR SELL SHARES OF THE FUNDS OR ANY OTHER FINANCIAL INSTRUMENT.
Standard & Poor's®, S&P® and SPDR® are registered trademarks of Standard & Poor's Financial Services LLC (S&P); Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC (Dow Jones); and these trademarks have been licensed for use by S&P Dow Jones Indices LLC (SPDJI) and sublicensed for certain purposes by State Street Corporation. State Street Corporation's financial products are not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, their respective affiliates and third party licensors and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability in relation thereto, including for any errors, omissions, or interruptions of any index.
SPDR ETFs may be offered and sold only in those jurisdictions where authorised, in compliance with applicable regulations.
Information related to Mexico
This information does not constitute and is not intended to constitute marketing or an offer of securities and accordingly should not be construed as such. The Funds referenced herein have not been, and will not be, registered under the Mexican Securities Market Law (Ley del Mercado de Valores) and may not be publicly offered or sold in the United Mexican States. Disclosure documentation related to any of the aforementioned Funds may not be distributed publicly in Mexico and shares of the Funds may not be traded in Mexico.
You should obtain and read a prospectus and KIID relating to the SPDR ETFs prior to investing. Further information and the prospectus/KIID describing the characteristics, costs and risks of SPDR ETFs are available for residents of countries where SPDR ETFs are authorised for sale on the SPDRs website and from your local SSGA office.