23 April 2020

As front-month WTI prices “rally” to above $15 a barrel early Thursday morning, the future is grim for many companies in the oil industry.  After oil prices broke into negative territory for the first time ever on Monday, a phenomenon in the futures market as the front-month contract expired, there are few options for the industry – particularly in the US where there are many independent and small players.

Reopening efforts are in serious question since little actual redundancy was built into the system during the shutdown.  The only solution is a massive wave of shut-ins as production must give way to abysmal demand and a dearth of storage.

Consolidation

  • Continued volatility in the futures market as participants try to resolve storage issues.
  • Production cuts will be expedited in the US shale (and elsewhere), eventually bringing price stability.
  • Unsustainable finances and poor business practices among lower-quality participants will lead to consolidation or elimination from the marketplace.
  • The best run companies with the strongest balance sheets will likely emerge historic winners in a much leaner landscape by Q4 2021.

US Policy Interventions

The US administration is likely to make policy moves that support the price of WTI – most effective would be a ban or tariffs on foreign imports and also buying American oil for the Strategic Petroleum Reserve.

The latter is highly likely at this point and the former contingent upon the palace intrigue between Saudi and US circles of influence, despite its obvious benefit to Americans working in that industry (so 50/50).

From a technical standpoint, these types of policy interventions would help support the short-term price of oil but demand is the key variable at play.

Super Contango

Contango is a market condition where the futures price of a commodity is higher than the spot price (oil is worth less today in the future, inverse of a normal market condition).

2021 and Beyond

Long-term, this will create new efficiencies within the industry and have additional positive second order effects for the US consumer; however, many that were working in the industry earlier this year will need to find new careers as only the best-run most professional companies can weather this downturn.

Capital Markets

If you’re thinking about investing, think balance sheet and reserves – the more professional the better but not all super majors are the same and that goes beyond the quality of their reserves.

Avoid companies that cannot produce free-cash-flow, of which there are many, since private equity will not be stepping in to save the industry as it stands today (like it did in the last oil downturn).

This will be a period where efficiency, scale, and quality of balance sheet will crown historic winners as the industry consolidates.

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Disclosure:  This is an opinion article not intended as investment advice – making investment decisions without your own evaluation of ideas is not investing; always do your own research and speak with an investment advisor, if you have one, before making any investment decisions.  Any opinions expressed are as of the date of publication.