Has Oil Finally Turned the Corner?

Written by: Gary Ashton

Last week the International Energy Agency (IEA) released its Oil Market Report for May, where they revised 2Q20 oil demand upward by 3.2 million barrels per day (mbpd) as countries around the world gradually ease lockdown measures. More importantly to the oil price is the sharp downward revision to global oil supplies. The IEA says they think the global oil supply will shrink by 12 mbpd in May alone to a nine-year low, led by OPEC+ countries.

The re-balancing of supply and demand has helped put a floor under oil price. Brent Crude, for example, is up 68% from a low of $19.33 per barrel reached on 21 April 2020. Even more spectacular is the United States Oil Fund LP (AMEX: USO), an exchange-traded fund (ETF) designed to follow the price of oil. It reached a low of $2.11 on 28 April 2020 and is closed at $22.39 last week. Other ETFs like the Energy Select Sector SPDR Fund (AMEX: XLE) are also off their lows. This ETF is up 57.3% from a low reached 18 March 2020, but still lags the broader market by a wide margin. Over the past 12-months, the fund is down 43.8% compared to the S&P 500 index, which broke back into positive territory last week at 0.45%.

Tanker Tops No Longer a Concern

The reduction in global supply removes one of the major concerns for the oil market. Until recently, traders were worried that rising oil supplies would face limited storage capacity. They were worried there would be no place to store inventories. This immediate risk has receded with reduced oil production and should continue to fall as demand recovers. The US Energy Information Agency (EIA) says after the first half of 2020, they expect global consumption to increase, leading to inventory draws for at least six consecutive quarters to the end of 2021 and putting upward pressure on crude oil prices.

Bottom Line

Energy has not been a popular investment choice lately. Even before the unprecedented demand destruction brought on by COVID-19, the energy sector was in retreat on environmental concerns. The sector’s poor performance prompted famed investor Jim Cramer to claim, “I’m done with fossil fuel stocks” in January this year. Investors may be writing off the sector too quickly, however. As the saying goes, the cure for low oil prices is low oil prices, which has a two-pronged effect. First, low oil prices push out inefficient suppliers, and second, low oil prices make it a cost-effective energy choice. For example, US gasoline prices are averaging below $2 per barrel. As the US moves toward recovery, competitive advantages like these will become increasingly important.

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