"Perfect Storm" in Oil Market Creates History

Tuesday, April 21, 2020

A perfect storm has hit the oil industry — a pandemic vastly lowering oil energy use, a nasty price war between major oil suppliers Saudi Arabia and Russia, and a futures contract expiration -- and conspired to take the price of oil to -$37 per barrel (bbl). Prices settled notably higher by the close of the oil market yesterday, but residual negative effects continue.

Because the last part of this perfect storm is a technical anomaly related to May contracts expiring today, it’s the least important in regard to longer-term investment perspectives. So as bad as they have made oil price conditions — including fertile soil for sensational headlines — near term, the real focus had ought to be on where oil prices go from here.

Futures on the West Texas Intermediate (WTI) benchmark for June contracts are down 28% this morning, to $14.71 per barrel. That’s not -$37, but that’s still very bad. Breakeven for an oil company — particularly a smaller Exploration & Production (E&P) firm — is more than double this amount. Going further out, July WTI futures are down 14.88% to $22.37; August is -12.66% to $24.90. Again, while these prices are improvements the further out we look, they are damning for the industry medium-term, as the cost of extracting and shipping crude oil far exceeds what the market is currently willing to pay for it.

As long as the airline industry remains mostly grounded, as long as cruise ships stay docked, and as long as Americans don’t take to the highways as they continue their “shelter in place” initiatives to limit the contagion of COVID-19, the supply glut for oil looks to continue. And earnings estimates for companies in these industries are falling sharply for Q2 and beyond.

According to Zacks Director of Research Sheraz Mian told me, “The only thing that will help the demand side of the equation is the resumption of ‘normal’ economic activities. Unfortunately, such a resumption of ‘normalcy’ is not in the control of any government…” We do see some states beginning to re-open their economies beginning as soon as later this week, such as Georgia, but this is not the same thing as the entire country re-opening for business. Further, moves to re-open too quickly might re-ignite the spread of coronavirus, which would be a longer-term setback for the economy, and thus an increased supply glut for the oil market, which would lead to lower prices for longer.

First quarter earnings results continue today, with Netflix NFLX the most anticipated of those companies reporting today, which will come after Tuesday’s closing bell. It will be joined by Chipotle CMG and Texas Instruments TXN; Coca-Cola KO and Lockheed Martin LMT are reporting Q1 results this morning.

Mark Vickery
Senior Editor

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