Market Update March 27, 2020 – Another Roller Coaster Ride
Market Update March 27, 2020 – Another Roller Coaster Ride
- Waycross Partners
- March 27, 2020
- Market Review
Last week was yet another roller coaster ride as investors digested a number of developments around the monetary and fiscal policy response to the spread of COVID-19 and early signs of the turmoil it is likely to cause the U.S. economy. The Federal Reserve announced open-ended asset purchases and other measures to support the flow of credit to employers, consumers and businesses. Congress passed a $2.2 trillion fiscal package to help offset the financial toll on businesses and consumers. Initial unemployment claims surged to 3.3 million, breaking the previous record of 695K in 1982. Ultimately, stocks recorded their best week in 11 years and posted back-to-back gains for the first time in over a month, even though the S&P 500 remains about 25% off its February high.
Chart of the Week
Sector Highlight: Energy
The Saudi/Russian decision to raise output came before the full impact of Covid-19 on world oil demand became apparent. We believe the combination of such a large negative demand shock combined with a large positive supply shock has driven oil prices below the levels needed to generate adequate revenues for these large producers to fund their economies.
If they continue on the current course, it is possible that all land-based and floating storage options could fill, and there would literally be no place left for any additional oil remaining in production. In such a scenario, we could actually see negative oil prices, as producers would need to pay someone to take it away.
The function of commodity prices and the shape of the commodity curve is to incentivize producers and storage operators respectively. At today’s prices, rational producers are incentivized to cut production, and we are seeing just that as North American producers and large international oil companies rapidly reduce activity. Owners of storage and traders are incentivized to buy oil today and simultaneously sell futures out the curve to lock in profits. Day rates for VLCC ships that can hold 2 million barrels are exploding (from below $50,000/day in 2019 to well over $200,000/day with some recent fixtures well over $400,000) as this will become one of the favored ways to store oil.
Longer-term implications of a prolonged price war would be significantly higher oil prices in a few years. Low oil prices in the near-term will result in delays or cancellations of offshore projects and shut-in production in large portions of North American land. As demand normalizes and storage is drawn down, production from North America will grow but be insufficient to meet demand. With low levels of spare capacity remaining in Saudi, and because offshore projects take several years to go from project approval to first oil, oil prices will rise until sufficient production returns to balance the market.
If Saudi and Russia are able to come to a face-saving arrangement in which OPEC+ cuts production in the near-term, oil prices should rise rapidly to $30+, the market will balance more quickly, the impact to Saudi/Russian revenues will less severe, and longer-term prices will rise less and more gradually.We are living in unprecedented times, but we remain committed to our investment discipline, maintaining long exposure to companies that have strong balance sheets and stable end markets that should be impacted less than average in a slowdown, and short exposure to more cyclical companies whose markets deteriorate more rapidly in a slowdown.
We are living in unprecedented times, but we remain committed to our investment discipline, maintaining long exposure to companies that have strong balance sheets and stable end markets that should be impacted less than average in a slowdown, and short exposure to more cyclical companies whose markets deteriorate more rapidly in a slowdown.
