The price of US oil dropped below $0 a barrel for the first time in history yesterday, making clear the volatility facing energy companies and the funds that invest in them. 
Oil has been one of the major investment themes of 2020, as the price war between Saudi Arabia and Russia combined with subdued demands from the coronavirus lockdown recession to push its value down.
As the chart below shows, both Brent crude and West Texas Intermediate (WTI) crude oil have slumped over 2020 so far, after Saudi Arabia ramped up production and demand for the commodity fell by as much as a third during the lockdown.
Performance of oil in 2020
Source: FE Analytics, in US dollars
Yesterday saw the most extreme event in the oil price plunge, when WTI closed Monday’s session trading at minus $37.63 a barrel. The negative price of US oil reflected the fact that producers were paying buyers to take it off their hands given limited access to storage in the US, driven in part by the technicality of the global oil market.
Today is the final trading day of WTI futures contracts for delivery in May and oil traders were offloading these contracts to avoid having to take delivery of the oil and incur storage costs.
The price of WTI crude has rebounded this morning, but traders say the June contract may come under pressure even though the Organization of the Petroleum Exporting Countries (OPEC) will soon reduce production.
Fiona Cincotta, financial market analyst at GAIN Capital, said: “The global oil glut has become so large that there is no longer space left to store the oil. The market panicked and the price fell to an unprecedented historic low of -$37.63 overnight. No-one was willing to buy oil contracts that expire today, and those who were willing to buy and store were rewarded.
“What is happening should shock the oil producers into acting in a more meaningful way to shore up the price of oil. Despite the Covid-19 lockdown oil producers continued pumping oil regardless of the growing glut. The planned OPEC cuts aren’t set to kick in until 8 May.
“It will take either a hefty increase in demand, or another round of deeper cuts to take the panic out of the market. Given that any easing of lockdown measures will be slow and controlled, that only leaves more action from OPEC+ as an option to stabilise the price.”
Jai Malhi, global market strategist at JP Morgan Asset Management, described the recent fall in oil demand as “unprecedented”, pointing out that is more severe than the ‘Great Recession’ of 2009, and warned that it will continue to hit energy companies hard.
Performance of global energy stocks vs global equities in 2020
Source: FE Analytics, in US dollars
“This level of oil price is not sustainable for any global oil producer. Even for Saudi Arabia, which has a low cost of production, this is not viable. Such low prices will not last and the pressure on storage will likely force OPEC+ into further production cuts in order to boost prices,” Malhi added.
“The energy sector will face significant challenges in the coming months. Corporate earnings will likely have further to fall and preserving liquidity will remain a main task until the supply and demand imbalance can be corrected.”
Clark Fenton, manager of the RWC Diversified Return fund, believes that the fall will push the US government to step in and shore up its oil industry.
The US economy has already suffered a spike in unemployment claims because of the coronavirus lockdown and further weakness in the oil industry could make this worse. Weaker US prices also threaten the country’s energy independence while the economy will be under scrutiny given 2020 is a presidential election year.
“Because of these factors we now expect to see intervention in the energy markets from the US government,” Fenton said. “President Trump will not want to let the US oil industry fail and, while there will be winners and losers in terms of the companies involved, we expect the US to save its energy industry.”
For UK oil companies, the picture is less dire. Brent crude, which the oil typically refined in northwest Europe, is more stable than WTI as storage capacity is less stretched.
However, OGUK – a representative body for the UK’s offshore oil & gas sector – has warned that that the volatility in the US oil price will hold back the UK energy sector’s ability to recover and called on the government to come up with a “Covid-19 resilience package”.
OGUK chief executive Deirdre Michie said: “While we have anticipated continued pressures on oil markets, there’s no getting away from the fact that this situation is a body blow for an industry already creaking under the strains of the impact of Covid-19 and sustained low commodity prices.
“The dynamics of this US market are different from those directly driving UK-produced Brent, but we will not escape the impact. Ours is not just a trading market; every penny lost spells more uncertainty over jobs, our contribution to public services and to the just transition we all want to see.”
The falling price will also have an impact on funds that focus on energy stocks.
As the table below shows, these have been the worst performing funds of the entire Investment Association universe in 2020 with some strategies dropping more than 40 per cent in 2020 to date. Latin American funds are also well represented in the table, reflecting the region’s reliance on oil exports.
Source: FE Analytics
Adrian Lowcock, head of personal investing at Willis Owen, warned that steps may need to be taken to prevent mass outflows from energy funds.
“We’ve had many shocking twists and turns in this downturn, and this collapse in US oil prices into negative territory for the first time ever is another major point in the crisis,” he said.
“For investors, we would expect to see more pain in energy stocks in the short term and there will be mounting concerns about energy funds themselves, which are purely exposed to the sector. If this price weakness continues we may see some emergency steps introduced to prevent a rout in those funds.”