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.