Last time Europe started shutting down, the oil price tanked. Not long after, futures contracts in the US reached negative territory due to a lack of storage space, and producer earnings crashed. Conditions are not as dire as in March and investors are now much more cautious about oil, but the actual risks are similar. Of course, the first shutdown covered a far greater area than just Europe, but these new restrictions will have an impact on oil demand.
In recent weeks, oil has been stuck in a fairly narrow range as traders try to gauge the demand hit as citizens across Germany, the UK and France stay at home. There is also the prospect of further lockdowns in the US to stop rising cases there.
Between the last week of October and the start of November, Brent crude bounced between $37 and $42 a barrel (bbl). The biggest drop came after the lockdown announcements, which arrived just as Libya was ramping up supply. The North African nation has increased production sharply, and consultancy Rystad Energy sees output going from an average 375,000 barrels of oil per day (bopd) in October to 750,000 bopd in November and 1m bopd by February.
So there is uncertain demand, increasing global supply, with output hikes seen outside Libya as well, and the US election wildcard.
The stocks
London’s oil and gas producers have had a tough year. When the seriousness of Covid-19 became apparent in March, Brent crude crashed to $25 a barrel, before falling further in April to below $20 a barrel. The global shutdown that slashed demand was helped along by Saudi Arabia upping supply in reaction to Opec talks not going its way. The summertime recovery from the pandemic saw prices climb back to $40 a barrel, where they have sat ever since. Earnings and valuations tumbled on the back of the first-half price action, and Royal Dutch Shell (RDSB) and BP (BP.) have brought forward business transformations that have cut dividends and will lead production falls in the coming years as capital spending once marked for reserve increases moves to green assets.
The supermajors have yet to show investors this new approach will deliver both environmental wins and returns equal to those oil and gas have provided for decades. The US majors' share prices are also trading at levels not seen in 13 years in the case of Chevron’s (US:CVX) and 18 years for ExxonMobil (US:XOM). This is all without committing to massive changes to stay palatable to investors, although Exxon announced last week it would cut 15 per cent of its workforce, equal to around 14,000 jobs.
For smaller producers, share price performance has tended to depend on the individual company’s balance sheet and production costs. To take two examples, Cairn Energy (CNE) and Genel Energy (GENL) have partly recovered after the March lows, with Cairn now just 29 per cent down in the year to date and Genel off by 40 per cent. This compares positively with the 56 per cent fall in the shares of Shell.
What next?
If we cast our minds back to early March, there was one big difference compares with the current wave of lockdowns: China. Then, the powerhouse was recovering but still had widespread restrictions in place. Now, there is no indication it is having its own Covid-19 resurgence troubles, and this week announced it would increase oil imports. Other positive indicators are the copper and iron ore prices, both of which are rising on the back of continued demand and stimulus in the Middle Kingdom. That may not be enough to shake the lockdown's effect on the oil price, however – in the seven days to 2 November, Brent dropped to $37 a barrel, its lowest point since June. Rystad thinks the market reacted reasonably to what will come next.
“It is not just bearish traders sweating over what’s coming, it’s a very logical price move,” said analyst Paola Rodriguez-Masiu. “The pandemic’s second wave was a development largely ignored in market pricing during the summer and now the pandemic has returned with a bang.”
Alongside uncertainty over the length of the European lockdowns, there is the impact of the US election to consider. Rystad sees a short-term boost from a Donald Trump win and a long-term boost from a Joe Biden win, given his plans to act on Covid-19 and move away from trade protectionism, although a Democrat win could also see supply increase from Iran and Venezuela.
In the short term, there is also uncertainty over supply. Currently, Opec and 10 non-member states are planning to add a combined 2m bopd to global production from January, as part of the unwinding of April's 9.9m bopd cut. Global average oil demand for 2020 is forecast at 99.9m bopd, according to the International Energy Agency, so the decision to put off the increase would keep 2 per cent of global demand out of circulation.
There are some bulls around. This week, Saudi Aramco (SA:2222) maintained its quarterly dividend, worth $18.8bn. Chief executive Amin Nasser said “early signs of a recovery in the third quarter” meant the largely state-owned producer could continue with its payout. It’s not hard to be bullish when you’re making a profit of $11.8bn in a quarter when the average realised oil price is almost $20 a barrel below the previous year. US producers have been ramping up supply as well, although some production is coming back online after hurricane season in the gulf.
Up or down?
The Opec scenario looks positive for the oil price, even if demand falls in the coming weeks and months. Saxo Bank’s head of commodity strategy, Ole Hansen, said prices were likely to stay within the $35.50-$42.50 a barrel range. “We are... very unlikely to witness a renewed collapse in crude oil prices similar to what we saw back in April,” he said.
While $36 a barrel will still make earnings recovery difficult for producers, it’s a long way from the dark days of April.
