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Tuesday 21 April 2020
Perspectives, Investment Talks
All Eyes on Oil Futures
The May 2020 West Texas Intermediate crude (WTI) futures contract moved into negative territory for the first time in history on April 20, trading as low as -$38.45/barrel (bbl). A key reason for the selloff was that the May contract expires April 21, and with the lack of storage capacity in the US, and to avoid having to take physical delivery of crude oil, those who were long the May contract were forced to sell their position into a market with no buyers. This was exacerbated by heavy ETF ownership of the May contract as ETFs typically roll positions into the next month (i.e. from May to June) by selling the expiring contract to buyers willing to take physical delivery. The volume-weighted average price (VWAP) of April 20 trades in the May contract was ~$10/bbl, so only a few small trades late in the trading session drove the price down.
The June contract will now be front-month for oil futures and will be important to watch. A similar dynamic has already started to play out in morning trading on April 21, with June falling to $16/bbl from $21/bbl at yesterday’s close, though in my view the magnitude won’t be as severe as the May contract given US production will be falling materially over the next month. Recent estimates indicate that US oil production could fall by as much as 25%, or 3 million barrels per day, through May. At the same time, while most of the US remains under lockdown, it’s unlikely that demand is still declining. Rather, we are likely moving along the bottom until states begin to reopen. Therefore, while storage will still be filling over the next 30 days, the supply/demand balance should actually start to improve.
Up Next: Production Cuts
US producers have already started to voluntarily curtail production (estimated at ~750-800mbpd) and this will accelerate in the next couple of weeks as companies report Q1 earnings. On top of this, we are approaching a situation where producers are forced to shut-in volumes as storage and pipelines are filled and midstreamers reject barrels. The Texas Railroad Commission is also expected to vote today on whether or not to curtail the state’s oil production.
Regional price differentials had already been trading well below WTI, so the impact to producers won’t change relative to last week. Bottom line: all US producers are going to be forced to curtail production either because it’s not economic or there’s nowhere for it to go.
Impact Across Energy Value Chain
Energy producers with hedges (primarily High Yield credits) will be relatively insulated in the near-term on the economic side, but even still, they may be forced to cut production due to the takeaway/storage issue. Unhedged producers are more at-risk, though most are larger, better-capitalized Investment Grade credits that are more able to withstand the impact.
Moving down the energy value chain, midstream companies levered to gathering and processing will be most negatively impacted as production falls, but those with storage assets are set to benefit. On the services side, the land drillers and pressure pumpers are going to see unprecedented weakness, with the pumpers hit hardest as well completions evaporate. Lastly, the refiners are suffering from refined product demand weakness (gasoline, jet fuel) and are cutting back on throughput, though we believe they will be a medium-term beneficiary, as refined products have limited shelf life and production will have to rebound when economic activity resumes. They will also benefit from lower feedstock (oil) prices when this happens.
Storage capacity at Cushing, OK, the largest oil tank storage farm in the world, is 76mmbbl, and while data is lagged, storage may be full in 3-4 weeks at recent build rates. Clearly this is what US prices are telling us. Globally, remaining storage capacity is ~1.8 billion bbl, which at an oversupply of 30mmbpd, leaves about two months before global storage is fully tapped out.
Opportunities in Energy
We believe there are selective opportunities in the fixed income energy sector, particularly in higher-quality midstream energy companies involved in activities including the storage and long-haul transportation of crude and refined products. These may include companies that specialize in operating tanker ships, pipelines, or storage facilities.
Unless otherwise stated, all information contained in this document is from Amundi Pioneer Asset Management and is as of April 21, 2020.
The views expressed regarding market and economic trends are those of the author and not necessarily Amundi Pioneer Asset Management, and are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets or sectors will perform as expected. These views should not be relied upon as investment advice, as securities recommendations, or as an indication of trading on behalf of any Amundi Pioneer Asset Management product. There is no guarantee that market forecasts discussed will be realized or that these trends will continue. These views are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets or sectors will perform as expected. Investments involve certain risks, including political and currency risks. Investment return and principal value may go down as well as up and could result in the loss of all capital invested.
This material does not constitute an offer to buy or a solicitation to sell any units of any investment fund or any services.
Date of First Use: April 21, 2020.
Investment advisory services are offered through Amundi Pioneer Asset Management, Inc. and Amundi Pioneer Institutional Asset Management, Inc. (collectively "Amundi Pioneer"). Not all Amundi products and services are available in all jurisdictions.
Amundi Pioneer Asset Management is the US business of the Amundi Asset Management group of companies. ©2020
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