There are certain times in your life that stick out; mostly personal to yourself and your family, others for career reasons. For me, this week was another one of those. Welcome to News, Views and Truths.
Books will be written about the current economic and social circumstances in which we find ourselves. And this week, in particular, will have a whole chapter dedicated to it. The day oil went negative.
On Monday, for the first time in history, West Texan Intermediate (WTI) Crude Oil fell to a negative price, meaning that owners of oil were paying other market participants to take it off their hands.
Each month, WTI futures contracts need to be settled with physical delivery of crude oil. A futures contract is a legal agreement to buy or sell a particular commodity asset, or security at a predetermined price at a specified time in the future. They are a form of derivative; you may have heard that term used before.
Normally this happens each month without incident or drama. However, Monday was different.
The lack of available storage capacity for crude oil at the WTI contract’s delivery point of Cushing, Oklahoma, commonly referred to as the Pipeline Crossroads of the World, set off panic among traders holding derivative contracts, who found themselves with nowhere to put the oil. It’s not like you can simply store thousands of barrels of oil in your back garden.
WTI opened for trading on Sunday night at $18 a barrel but by the end of the day it had dropped to as low as minus $40 a barrel, as traders looked to get rid of their obligation to take the physical asset.
And this could be seen as the first major fallout from the coronavirus. It is estimated that some 3.6 billion people are living under lockdown around the world. Passenger flights have been grounded and many factories are empty. World oil demand is expected to plunge by a record 9.3 million barrels per day in 2020, according to the International Energy Agency.
However, the shock of this negative price move has resulted in reactionary measures. OPEC, Russia and a group of other oil-producing countries have already agreed to slash production by a record-setting 10 million barrels beginning in May. Market forces are causing non-OPEC producers, led by the United States, to similarly cut output.
Although the demand for oil will remain weak moving into the future, the efforts to stem supply will aim to bring some degree of equilibrium to the oil price, thus giving much-needed stability to both energy suppliers and economies that rely on the commodity as their main source of growth.
So, what effect will this have on investment portfolios? Obviously, it offers increased volatility to those who hold commodity funds. However, the bigger impact in my eyes will be the indirect effect on other, less obvious asset classes.
The concern is that the new wave of shale oil companies within the US will be damaged during forced shut-ins, making it trickier to turn them back on. That could limit the ability of US shale companies to respond to higher demand and some companies may not be around to turn the taps back on.
In a $20 oil environment, 533 US oil exploration and production companies will file for bankruptcy by the end of 2021, according to Rystad Energy. Even in a $30 environment, more than 200 US producers will go bankrupt. The effect of this could be catastrophic for the High Yield Bond market, with the majority of shale producers receiving funding through this type of debt.
Rather than being restructured in Chapter 11 proceedings, a form of US bankruptcy, some of these companies may be unable to get financing to stay alive; they will be forced to liquidate altogether. And if that happens, default rates will explode, leaving investors holding High Yield Bonds looking down the barrel of a double-digit loss. And remember, the average High Yield Bond fund is already down over 11% year to date.
I’d strongly suggest that everyone check their investment portfolios for High Yield Bond exposure; if you are invested within Three Counties’ portfolios, you’re fine. We have zero exposure.
Another thing that I would strongly suggest that you do, if you haven’t already, is sign up to our Investment Update this coming Wednesday at 11am, using the button below.
It’s online (obviously), but really easy to attend and you can hear from yours truly on the most recent thoughts of the Investment Committee, how our portfolios have fared against both the broad market and our competitors.
Let’s be honest, you don’t have anything else to do and you never know, you may enjoy it.
And talking of enjoyment, apparently, the weather is to be decent this weekend. So how about you enjoy our Three Counties/Greaves West and Ayre Megamix playlist below; I am sure there is something for everyone on it.
Have a great weekend and I shall see you all next week.
