Oil futures, like many other asset classes, is going through an extremely volatile phase. Why is this the case? Well you’ll be surprised that Coronavirus is NOT the deal-breaker here.
Following a series of troubled disputes regarding the supply and demand of oil over the past month, WTI crude has dropped 32% and the International Benchmark for Brent Crude is down 31%. But what is this a reaction to?
Russia has emerged as the main driver of this cause due to its rejection of OPECs efforts to cut oil production, which would have otherwise maintained current oil prices. The failure to reach a unanimous decision on limiting oil production has seen Russia losing between $100M – $150M per day as Russia’s oil competitors drastically increase their production rates, namely Saudi Arabia, who plans to boost crude output beyond 10M barrels per day (bpd) in April. This increase might have drastic impacts on the shale oil production in the US.
Speaking of which, the US, being the largest supplier of oil (14.71M bpd) has no plans to drop its production as it continues to gain a greater market share. Its growing shale oil production caused major disruptions since 2014, when OPEC was forced to cap output rates in order to maintain prices (much like the current problem). This policy, albeit stabilized prices, kept the US shale oil producers in business which ultimately caused further expansion and thus an excessive supply.
OPEC dealt with this problem the same way as before and are since locked into a continuous cycle of constantly cutting rates to solely reduce US production. Russia, who also requires money from its oil exports sees this predicament as one that boosts US producers at the expense of all other nations. To break the cycle, Russia disagreed to the recent request by OPEC which ultimately fueled uncertainty in the markets leading to the recent drops in oil price.
With the demand of oil declining sharply due to the Coronavirus epidemic, compounded with a warm winter in the US, reduced jet travel, and now no limit on production rates, we are about to expect an extremely excessive supply of oil, but what implications does will this have on your portfolio?
Future forecasts suggest that the oil industry might take a long time to recover. With Electric Vehicles (EV) continuing to gain market share, investors realize the declining need for oil, especially in the US where gasoline accounts for 45% of oil usage. Junk bonds (high yield-debt instruments), which have a high concentration in the energy sector have also taken a hit and the future of their value remains uncertain. Compounded with bond markets being closed to low-rated energy companies, there is a high chance that a wave of restructuring is bound.
Featured picture of Cowboy farmer and oil pumpjack by Getty Images Blog article written by Divik Nigam, Research Analyst, Maqro Capital