Just months ago, predictions that the Oil price would fall below ZERO when it was around $40 a barrel would have been treated with incredulity. However, that is exactly what happened in early April. There are technical reasons for this. There is not just one price for Oil. There is the spot price if you buy it for today out of storage and then there is the futures price for monthly delivery. May, June July and so on. Each month that months contract is settled, and buyers arrange to take delivery. In April, many holders for April delivery rushed to sell as there was already too much in storage. Many were so keen not to take delivery they sold their contracts on the market at negative prices. Effectively paying someone to take it from them.
This situation had been caused not just because of COVID 19, although clearly this was a large part of the fall in demand, but also because Saudi Arabia had in March decided to product more Oil in order to under cut the price of US Shale gas and also to remain cheaper than Russian oil exports and this is where it gets really interesting.
Firstly, for many of our clients, BP and Royal Dutch Shell are among the highest dividend payers with many clients and pension funds relying on those dividends for income. This week both BP and Royal Dutch have continued to pay their dividends which is great, especially why other companies have cancelled theirs. Royal Dutch have reset their dividend to a lower amount but will still be around 4%.
Oil was going through a structural change before COVID 19 with many countries beginning to pursue more economically friendly sources of energy and the rise of electric cars. Electricity from Wind and Solar has become incredibly efficient and competitively priced against natural gas and oil. Perhaps the Saudi Crown prince by lowering his prices so steeply was on to something by trying to under cut all his competitors.
Then came COVID and the massive fall off in demand.
What could happen next could include more instability in the Middle East. Russia now with its foothold in Syria and growing interests in the region, could choose to try and influence Saudi to reduce its output further to increase the price. That could be by using proxies to destabilise the kingdom. That may sound far fetched but with COVID causing such disruption to economies, events could quite easily get out of control.
Another possible outcome is that the oil price simply stays a lot lower for a lot longer reflecting the rise of other energy sources and further structural change. For example, air travel seems unlikely to pick up to previous levels for some time. Why would businesses pay millions in business class fares when sales staff can simply have a Zoom call?
For portfolio’s it is sensible to diversify and look at funds which hold Solar and Wind assets. These funds usually have underlying investments with 20 to 25-year contracts to supply electricity so make ideal income investments as their cash flows and dividends are predictable.