Coronavirus along with the 2020 Oil Crisis
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The coronavirus has forced more than 150 countries to shut down parts of their economies to fight the virus, driving the fastest stock market declines in history. Another major factor behind the global sell-off has been a sharp drop in the price of a barrel of oil. On Friday, March 6, 2020, U.S. crude oil was $41 per barrel. In the United States, oil trades as West Texas Intermediate (WTI), a light sweet crude, while the global benchmark is Brent Crude (CL=F), also a light sweet crude; both refine easily into gasoline. Both are traded as commodities in the futures and index markets. OPEC — the Organization of the Petroleum Exporting Countries — is made up of 14 major oil-exporting nations and is tasked with coordinating policy among its members and helping stabilize oil markets.
After the stock markets dropped substantially in early March, news broke on the evening of Sunday, March 8, 2020 that Saudi Arabia and Russia had launched a price war. Neither would agree to cut production. The reported aim was to drive prices low enough to push U.S. shale drillers out of business. Instead, both countries kept pumping even as demand collapsed because of coronavirus lockdowns, and the price per 42-gallon barrel continued to fall. As this article is being written, President Trump has spoken with both countries, and there is hope that on Monday, April 6, 2020, the two will meet alongside OPEC to discuss cuts. Both WTI and Brent have already rebounded more than 30% on that optimism. The chart below shows the price history of both benchmarks — the yellow line is WTI and the blue line is Brent — from 1988 to 2020. On April 3, 2020, WTI closed at $28.34 and Brent closed at $34.11 per barrel.
Annual oil consumption has been declining since 2005. Americans have been pushing back against foreign oil for years; the supply-side shift started even before U.S. shale drillers commercialized fracking. Drivers switched to more electric vehicles, hybrids, and fuel-efficient cars and trucks. Before the U.S.–China trade war, China’s booming economy had pushed oil above $100 per barrel and U.S. gasoline above $4 per gallon. In the 1970s, U.S. farmers began producing ethanol from corn and blending it into gasoline to stretch supply and ease prices.
To understand the oil sector, it helps to define petroleum. Petroleum is a fossil fuel formed from the decayed remains of prehistoric plants and animals. It is a mixture of hydrocarbon molecules — combinations of hydrogen and carbon — that occur sometimes as a liquid (crude oil) and sometimes as a vapor (natural gas). Source: Energy Sources | Energy4me. The U.S. pioneered a new drilling process called hydraulic fracturing, or fracking, used on shale rock. Put simply, traditional oil and gas wells were drilled vertically; fracking allows drillers to extend horizontally through shale formations that were previously uneconomical. Fracking is important for investors to understand because it transformed the U.S. into one of the world’s largest oil and gas producers.
There are several ways to invest in oil. Trading a barrel of oil directly via futures is highly risky, and not an approach CFE Finances teaches. Instead, we recommend considering different types of oil-related companies. These are not recommendations, but examples: you could look at refineries, pipeline companies, or integrated producers. HollyFrontier (HFC) is a U.S. refiner that produces gasoline, diesel, jet fuel, specialty lubricants, and asphalt; it is trading at $22.38 at the time of writing. Phillips 66 (PSX) is another U.S. refiner, currently trading at $51.62. The refiner business model is to buy crude at a lower cost and refine at higher margins. A wider spread between WTI and Brent generally helps U.S. refiners.
Another type of oil investment is an MLP — a master limited partnership — which distributes 90% of earnings back to shareholders as quarterly dividends. Energy Transfer LP (ET) is an MLP that provides energy-related services. Kinder Morgan Inc. (KMI) was previously an MLP but converted to a corporation, which freed it from the 90% distribution requirement. That let the company reinvest cash in growing the business, but the dividend cut drove the stock lower because existing shareholders were unhappy. Kinder Morgan owns and operates natural gas and crude oil pipelines across the U.S. Kinder Morgan, HollyFrontier, Phillips 66, and Energy Transfer have all fallen substantially from their 52-week highs.
Other names in the oil and gas sector that pay healthy dividends include Chevron (CVX), ExxonMobil (XOM), and ConocoPhillips (COP). These stocks have also dropped significantly from their highs. There are plenty of others worth researching — if you have questions about a specific company, we can help you dig in. As investors, we’ll keep monitoring the oil space as it stays volatile, and watch how movements there affect broader investing. At CFE Finances, we review different industries when they look like attractive future investments or when they have the potential to move the rest of our portfolio. Oil in particular deserves close attention because of how central it is to every major economy.
As I finish this article on Sunday evening, April 5, 2020, CNBC is reporting that oil is indicated to open down 9% on Monday, because the OPEC meeting with Saudi Arabia and Russia has been delayed to Thursday, April 9, 2020. Keep an eye on the markets this week. Good luck and happy investing from CFE Finances! Stay safe and healthy. We’ll be in touch with another newsletter soon. If you have any questions or concerns, please email us from our contact page.