Oil struggling to find momentum

Aug 13, 2020

For most of my investing life, I have been a part of the upwards bull run spanning nearly a decade. Growth stocks outperformed cyclical and value, interest rates were kept low, and oil was at favorable prices. However, this year I experienced two unprecedented events: The Pandemic and negative oil prices.

Both the pandemic and negative oil prices come hand in hand
Pandemic forced everyone in their houses, forcing a build up in oil inventories. So much so, that storage was filled to the brim, and oil producers were paying buyers (what a weird statement) to take their oil – hence, negative prices.

Since that historic day, oil prices have doubled, and Brent Crude has stabilized around the $40 – $45 range. However, it struggles to find momentum getting back to the glory days of $60 and $70 a barrel for oil.

If New Zealand is to be followed, higher prices for oil may be unlikely
We are all optimists at heart – no matter our opinion, we want things to be better than expected. Better than expected results for earnings means we get a boost in a stock price. Better than expected, Coronavirus vaccine results mean we can return to a life of normal quicker. However, in the words of Prime Minister of New Zealand, Jacinda Ardern, “Things will get worse before it gets better.”

Jacinda’s statement was on the back of New Zealand recording more Community transmitted cases after 102 days of no community transmitted cases. Two things can be deduced from this:

• No matter how successful you are at flattening the curve, just like New Zealand has, community transmission is inevitable
  
• If we argue that New Zealand has relatively been the most successful in trying to get rid of the virus through their harsh lockdown measures and there still is community transmission – how is the rest of the world going to cope?
  

Oil isn’t just about supply
This is important because no matter how much suppliers restrict the supply of oil, there are two sides to the picture – the other side being demand. If New Zealand, after fully flattening the curve for 102 days, goes into another lockdown, can we assume that the rest of the world will follow a similar trajectory? Not to mention that countries like the United States and places like Victoria, Australia, have not been able to achieve what New Zealand has. Countries like Japan and Australia were initially praised for their low Coronavirus cases. However, they both have seen spikes due to community transmission.

That is a long-winded argument to back up the idea that Oil demand (and therefore oil prices) are inversely correlated to potential second lockdowns. And that may be the reason as to why we do not see oil push past $50 a barrel anytime soon.

Oil producers are hoping that that the Coronavirus doesn’t force a second lockdown
The International Energy Association (IEA) reported they predict oil demand would average around 91.9 million barrels a day (BPD) in 2020. This is 8.1 Million barrels a day lower than the average of 100m BPD last year. Quick maths

• Average oil prices were around $64 a barrel in 2019
  
• Currently, Brent is sitting at around $45 a barrel in 2020
  
• Difference is $19 a barrel
  
• $18 x 8.1 = $15.4 Billion of average potential oil revenues a day lost due to the Pandemic
  

That $15.4 Billion is assuming that oil prices stay at $45 and demand staying at an average of 91 Billion barrels a day this year. If a second lockdown occurs, we will see oil demand drop and the price of oil drop, causing a double blow to producers.

IEA noted that “Recent mobility data suggests the recovery has plateaued in many regions” and that the global oil supply was expected to be roughly steady in August. Assuming that demand is constant in August, we should see Brent Crude oil stay around the $45 mark. However, a second lockdown across the world as OPEC slowly increases its supply will lower oil prices.