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EVEN IN A WORLD THAT HAS GROWN ACCUSTOMED to the possibility of negative interest rates, the idea of negative oil prices—paying people to buy oil—seems almost unfathomable. Yet that’s what happened on Monday, when West Texas Intermediate (WTI) oil prices dropped to nearly minus $40 per barrel before climbing back into positive territory by Tuesday morning. Still, the precipitous decline was enough to spark volatility, impacting not just the shares of energy producers but the broader market overall.
While lower energy prices are usually good news for consumers, the current state of oil prices is a reflection of the massive disruption to people’s lives caused by the coronavirus, says Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank. “The massive oil supply glut is driven by the sharpest-ever contraction in demand. There’s nowhere to store oil right now, and nobody wants to take delivery.”
What’s likely ahead for energy and the economy?
Economically speaking, this has been called a crisis of mobility, says Hyzy. “We’re not traveling to work, to hotels, to restaurants or on business trips.” Recovery for the oil industry and the broader economy hinges on when governments and individuals decide that it’s safe to start moving again, he adds. Hyzy outlines three possible scenarios below:
To ease the current historic glut, oil producers are likely to shut down supply for May and June, Hyzy believes. In the months to come, oil prices will have to climb back to about $50 per barrel to at least cover the cost of production, he says. That could happen either through renewed demand or, if recovery stalls, through industry consolidation, as many smaller producers are forced out of the market.
What can investors consider?
We anticipate an extended period of recurring volatility as declining oil prices and other economic impacts of the coronavirus resolve themselves, says Hyzy. With so much uncertainty regarding both the health crisis and the economy, he suggests maintaining a portfolio diversified both across and within multiple asset classes. He also recommends focusing on high-quality investments, particularly in large U.S. companies that pay dividends, and on rebalancing to make sure portfolios stay invested towards long-term goals.
Information is as of 04/22/2020
Opinions are those of the author(s) and are subject to change.
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