by Bryan Perry

May 27, 2020

One of the biggest stories of 2020 – and one that will go down in history – is the total price collapse of crude oil and the subsequent spike in oil prices that followed.

On April 20, the price of West Texas Intermediate (WTI) crude plunged into negative territory, bottoming out at a negative -$37.63 per barrel. As of last Friday, May 22, WTI had rallied back to $31.84 per barrel.

West Texas Intermediate

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

This turnaround marked an amazing feat that was juiced by widespread temporary production cuts and massive short covering. I view this snapback rally as an incredibly good opportunity to short crude oil – and the energy sector as a whole. Aside from a full-scale war breaking out in the Middle East, it’s my position that oil is in a secular bear market, one in which the shorts stand to profit handsomely.

Global demand, led by China’s contracting economy, is slowing, while Saudi Arabia’s and Russia’s unwillingness to cut back production in late March triggered the gradual selling pressure that culminated with the waterfall whoosh lower in mid-April prices.

Production Consumption

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The U.S. Energy Information Agency (EIA) analyzed reductions in oil demand by evaluating three main drivers: lower economic growth, less air travel, and other declines in demand not captured by these two categories, largely related to reductions in travel because of stay-at-home orders.

Based on incoming data and updated assessments of lockdowns and stay-at-home orders across dozens of countries, EIA has lowered its forecasts for global oil demand in 2020. OPEC is expected to begin increasing production in July in response to rising global oil demand and the rebound in prices.

From that point, the EIA expects a gradual increase in OPEC production through the remainder of their Ouija Board forecast, with production rising to an average 28.5 million b/d in the second half of 2021.

The EIA also expects that OPEC’s surplus crude oil production capacity, which averaged 2.5 million b/d in 2019, will average 5.8 million b/d during the third quarter of 2020. EIA expects it to decline to an average of 3.7 million b/d in 2021 with increased production as the targeted cuts are relaxed.

These surplus numbers will likely be pulled fast forward given the extent of cheating on quotas by global producers. Cheating is a permanent phenomenon. For price shocks of typical historical size, most members overproduce their quotas regardless of the direction of real oil prices in the medium to long run.

Surplus Capacity OPEC

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The base case for shorting the energy patch is three-fold.

  • First, the world is awash in crude oil, and though there has been some rebalancing of late, structural future demand for oil looks soft as demand levels off and production is forever increasing.
  • Secondly, global demand for oil faces the rising wave of renewable energy that is making dramatic progress in replacing fossil fuels and the combustion engine. The global electric vehicle market was valued at $162.34 billion in 2019, and is projected to reach $802.81 billion by 2027, registering a CAGR of 22.6%. China’s current EV market is greater than that of the U.S. and Europe combined.
  • Thirdly, a growing number of pension funds, mutual funds, hedge funds, and retail investors have refused to own shares in carbon-generating companies anymore. Stocks of oil producing companies have been banished to the category of “sin stocks.” Carbon/energy stocks have been thrown into a category that includes tobacco, alcohol, opiate-producing, and gaming companies. Oil and gas stocks are now personae non grata in most ESG-compliant portfolios that include major pension funds.

Against this bearish backdrop, investors might consider shorting crude outright or shorting widely-traded energy ETFs like the Energy Select Sector SPDR ETF (XLE) by using long-term put options. This way if there is a spike in oil prices due to a geopolitical event, the risk to invested capital is limited to the amount of the cost of the put, and not a pure short, where there is unlimited risk.

There will be several attempts to manipulate the price of oil to support higher prices, primarily through temporary production cuts from time to time, but long-term, the trend looks to heavily favor the bears.

All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.

Please see important disclosures below.

Also In This Issue

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The Year of the Bat

Sector Spotlight by Jason Bodner
Record-Fast Recovery Makes for Restless Bears

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Read Past Issues Here

About The Author

Bryan Perry

Bryan Perry
SENIOR DIRECTOR

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry

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