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Unpicking the oil price plunge

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Summary

Coutts Head of Asset Management Mohammad Kamal Syed examines the implications of ‘black gold’ dropping below zero this week.

2 min read

Just when markets appeared to be settling down, history has once again been made. This time it’s oil hitting the headlines as prices fall below zero.

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Lockdown has brought demand for the commodity to a stand-still and storage space for it has run out. The result – market participants are literally paying people to take it from them.

This unprecedented state of affairs saw the price of a barrel of West Texas Intermediate – the benchmark for US oil – fall to -$37.

It’s important to note, though, that this is the price for oil delivered in May only. Oil prices for deliveries later this year remain positive at around $20-$30 a barrel.

As long as the US remains in lockdown oil prices will stay under pressure, but we believe the situation should normalise once the economy picks up. Oil prices had already been falling for some time so it was not the market shock it could have been. And because only the very near-term oil price saw this anomaly, the impact on energy assets has been limited.
 

What does this mean for the economy?

The negative oil price is a consequence of the technicalities of the oil market and not a reflection of the current state of the economy. That’s because no economic conditions could possibly lead to such a huge price drop. Even when the economy is weak, people still need oil to fuel the cars in their driveways and the machines in their factories.

The case therefore remains that the economy could very well spring back to life once the virus starts to fade and assets like oil return to normality.

It will take time – we may not see pre-virus levels of activity until next year – and it will depend on how central banks and governments rein in restrictions and adapt their support – but we believe it should happen.
 

How has it affected markets?

Oil prices have been falling dramatically since the start of the year after the combined impact of COVID-19 and an oil price war between OPEC and Russia.

This meant this week’s news was far less of a shock to the system than you might think.

Historically, commodity currencies, US high yield credit and of course oil companies have been strongly influenced by the oil price. But because only oil prices in the immediate future are impacted, and the valuations of those assets already reflected cheaper oil, they remained mostly stable following the news.

“As long as the US remains in lockdown oil prices will stay under pressure, but we believe the situation should normalise once the economy picks up.”
Mohammad Kamal Syed, Head of Asset Management

What does it mean for Coutts portfolios and funds?

At Coutts, we don’t hold outright energy investment themes or funds in our portfolios, and we don’t hold any direct exposure to oil futures.

We do have exposure to oil companies in our diversified funds, but again we would expect those companies to be driven more by the longer-term oil price outlook than these near-term prices.
 

Focused on the future

This development certainly proves that we are living in interesting times. We have simply never seen anything like it.

But it is yet another short-term symptom of the coronavirus, not a long-term trend. And although it will take time, current historic conditions will one day become just that – history. We will continue to monitor developments, study the data and stay nimble when managing your investments through this period and into the future.

If you would like to talk about this in more detail, please speak to your private banker or wealth manager.
 

mohammad-syed_author

MOHAMMAD KAMAL SYED

Head of Asset Management

When investing, past performance should not be taken as a guide to future performance. The value of investments, and the income from them, can go down as well as up and you may not recover the amount of your original investment.

 

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