Weekly Wrap from Pythagoras Investing 26 April 2020 : Oil

Oil : Big Winners and big losers by country and stock. 

OPEC is headed by Saudi Arabia.  Historically OPEC openly manipulates the production volume of oil to maximise profits – it is the usual practice; a known price fixing.  The USA has not participate in production cuts, instead usually increasing production when OPEC cuts.

In March 2020 when OPEC was trying to cut production so prices would rise there was a dramatic turn of events. Normally Russia would do the same as OPEC, but in the March price fixing meeting, Russia disagreed.  The result of the stalemate caused Saudi Arabia to go it alone by dropping its own price and increasing production.  This was an unprecedented and abnormal manipulation – a money grab for Saudi Arabia.  The oil prices dropped by about 30% to USD30.  The biggest loser was US Shale Oil industy.

Fast forward 6 weeks to the volume cuts agreed to by OPEC and friends.  They amounted to 10% of daily production.  The problem was that demand had fallen by 20-30%.

This week the oil futures contract for West Texas Intermediate crude dropped below zero.  Media have blamed this on a client who couldn’t sell.  But when you think about the whole situation it is interesting.  The seller knew the expiry date, knew there was no available storage and still waited until the last minute to sell – causing the price to go below $0.  Sellers were literally paying buyers to take the oil for -USD37 per barrel.  This makes little sense, unless the seller wanted to make a dramatic statement about the oil industry.  We believe it was a price manipulation to keep the USA oil industry down.  (The US is at the higher end of production costs.)  Why?  Perhaps a retaliation for producing more when others cut? Perhaps in retaliation for trade wars?  Or cold wars? 

Either way it sent a message to investors to turn against the industry.  No matter what Trump says there is no way he can afford to bail out the oil industry.  The talk of storing more oil is not a solution.  If there is more oil stored – the price will stay down for even longer.  Much of the industry is now unsustainable.  Production cuts are absolutely necessary – the only question is timing.

Currently there is a lot of bad news priced in oil shares.  Once production is cut again the next thing to occur will be the end of Covid-19 restrictions.  Once that occurs people will be using trains, planes and automobiles – and the use of oil will rise again.  Already Chinese roads are more congested than before the pandemic and air travel has grown 7% from March to April, albeit there is a long way to grow back to where it was 12 months ago.

Oil is not extinct – but some countries and some companies will do well, and others will not.  There are preconditions for oil companies to make great gains – stock choice is critical.  This has been our challenge – to find those with the highest possible return profile possible.

Like to discuss more. Please contact Michael Dee, michael@pythagorasinvesting.com