Unpicking the oil price plunge

Lockdown has brought demand for the commodity to a stand-still and storage space for it has run out. The result – market participants are literally paying people to take it from them.

This unprecedented state of affairs saw the price of a barrel of West Texas Intermediate – the benchmark for US oil – fall to -$37.

It’s important to note, though, that this is the price for oil delivered in May only. Oil prices for deliveries later this year remain positive at around $20-$30 a barrel.

As long as the US remains in lockdown oil prices will stay under pressure, but we believe the situation should normalise once the economy picks up. Oil prices had already been falling for some time so it was not the market shock it could have been. And because only the very near-term oil price saw this anomaly, the impact on energy assets has been limited.
 

What does this mean for the economy?

The negative oil price is a consequence of the technicalities of the oil market and not a reflection of the current state of the economy. That’s because no economic conditions could possibly lead to such a huge price drop. Even when the economy is weak, people still need oil to fuel the cars in their driveways and the machines in their factories.

The case therefore remains that the economy could very well spring back to life once the virus starts to fade and assets like oil return to normality.

It will take time – we may not see pre-virus levels of activity until next year – and it will depend on how central banks and governments rein in restrictions and adapt their support – but we believe it should happen.
 

How has it affected markets?

Oil prices have been falling dramatically since the start of the year after the combined impact of COVID-19 and an oil price war between OPEC and Russia.

This meant this week’s news was far less of a shock to the system than you might think.

Historically, commodity currencies, US high yield credit and of course oil companies have been strongly influenced by the oil price. But because only oil prices in the immediate future are impacted, and the valuations of those assets already reflected cheaper oil, they remained mostly stable following the news.