Having broadened and deepened its fixed income capabilities significantly over many years, AllianzGI is now taking the natural next step in the evolution of its fixed income offering by bringing its capabilities into an integrated, global structure.
Shockingly low oil prices will shake up the energy industry, but it should recover
Paul D. Strand
The coronavirus crisis and a price war have pushed the oil price well under USD 20 per barrel, with some futures contracts even falling below zero. We expect this to trigger many structural changes – both positive and negative – that investors will be able to factor into their portfolios before the energy industry recovers.
The unprecedented drop in the price of oil is the result of a “perfect storm” of events that we believe will have a lasting impact on the energy sector
We expect a shift in market share for today’s top energy sources: renewable energy and natural gas will likely gain share, and coal will likely lose share
Oil demand will almost certainly grow from today’s levels, but at a lower rate than before; we also expect global oil companies to focus more on capital discipline and ESG, and less on oil-supply growth
We anticipate that the energy industry will recover from this historic downturn, which presents compelling investment opportunities for the best-positioned companies
A “perfect storm” of events caused the oil price to collapse
Several events this year have pushed down the price of oil to historically low levels – including near-term (front month) oil contracts that shockingly turned negative for the first time in history. One of the primary reasons for this drop is the coronavirus crisis, which has led to a virtual full stop in economic activity and evaporation of oil demand. On top of that, Saudi Arabia and Russia launched an unexpected price war, further pressuring oil prices. The price war has abated for now, but the enormous demand contraction lingers, leading to an uncertain future for many segments of the global energy industry.
As a result of the oil-price collapse, we expect to see many structural changes – some negative, some positive – before we eventually emerge from the other side of this global crisis. Investors should look to realign their portfolios with this new reality.
Three key implications for the markets and economy
1. The US is likely to lose its lead as the largest global oil supplier
Driven by the prolific growth of US shale oil, the US has become the world’s largest oil producer. But extracting shale oil is highly capital-intensive, and this industry can’t function normally with oil prices below USD 40. Of course, prices recently fell well below USD 20 (see chart), which has put the industry under severe stress. We expect US production to drop sharply over the next two years, adversely affecting US trade balances and causing further economic stresses in oil-producing states.
The oil-price drop is unprecedented, but well below its historical average
WTI oil price, last 15 years (2005-2020)
Source: FactSet. Data as at 21 April 2020.
2. Energy producers will likely change their spending habits
Given the historic severity of this downturn, we expect the global oil industry will become even more stringent with their capital investments, both out of necessity and by design. Balance-sheet strength will become paramount and share repurchases will likely become less important. We expect to see an increasing focus on delivering returns on capital, and on environmental, social and governmental (ESG) measures. We also expect to see less emphasis on oil-production growth.
3. Energy demand could change permanently
Throughout history, economic growth has been accompanied by increased energy consumption. So even though the world is in a pronounced economic slowdown due to the coronavirus, we expect economic growth and energy consumption will eventually return. But we also think we’re likely to see structural changes in the composition of energy demand as people and companies change their behaviour. Some examples:
Structural change from coronavirus
Potential impact on energy sector
Working from home becomes commonplace
Lower gasoline demand from consumers
Business travel stays low as high-quality video conferences become an acceptable substitute for in-person interaction
Lower jet fuel demand
People keep spending more time at home
Demand for natural gas grows quickly to sustain growing electricity and heating/cooling needs
Demand for cloud computing services soars
Cloud computing consumes an enormous amount of electricity – generated by natural gas and renewable energy sources
Supply chains become more domestic and less international
Higher demand for diesel fuel used in railroads and trucking
Demand for cleaner air grows, as society appreciates the lower pollution levels that coincide with lower economic activity
More reliance on renewable energy sources, and new strategies to reduce the environmental impact of industry activities
We expect to see a cyclical recovery – eventually
While it may be difficult to envision how the world recovers from this downturn, oil prices at these historically low levels are unsustainable. The industry seems certain to reduce the oil supply profoundly, and we expect a significant post-coronavirus surge in oil demand. Other factors are likely to push up the oil price over the long term, including fewer major projects due to lower capital spending overall, and more investment in renewables and power to satisfy ESG objectives.
In the immediate term, the oil-price collapse and sudden economic downturn can certainly make investors hesitant. But the coronavirus crisis will eventually pass, leaving a changed energy industry in its wake. Investors would be wise to position their portfolios accordingly.
Renewable energy companies are likely to grow rapidly, though major projects may be delayed until the economy and credit are on better footing.
Refiners should get a boost from a resurgence in demand and their solid track record of capital allocation and free cash generation.
Natural gas companies have a bright future as increased telecommuting and cloud computing push up demand for electricity; this should benefit liquified natural gas (LNG) and pipeline companies.
High-quality oil companies should survive the industry shakeout as the crisis transforms the energy sector. The world will still need oil for a long time, and the lowest-cost producers with the strongest balance sheets should be able to benefit.
Consumers will soon start capitalising on lower gasoline and energy prices, aiding the inevitable economic recovery.
Director, Portfolio Manager, Senior Research Analyst & Sector Head, US Resources
Paul, CFA, is a portfolio manager, a senior research analyst and a director with Allianz Global Investors, which he joined in 2003. He is Sector Head of the US Resources team and is responsible for analytical coverage of integrated oil, oil and gas production, refiners and oil services.
Emerging markets need foreign investment as coronavirus spreads and capital flows out
Even as the developed world slowly comes to grips with the coronavirus outbreak, the struggle in emerging markets is just beginning, and many foreign investors have grown wary. Social distancing and other containment measures are creating significant risks to EM economies. Still, some countries – including Russia, Brazil and China – could be set to rebound when capital begins flowing back in.
Emerging markets are experiencing a humanitarian crisis that could overwhelm their healthcare systems, but they must focus on limiting economic damage as well
EMs can enact monetary and fiscal policy changes that provide liquidity and reduce financial risks, though they can’t protect against supply and demand shocks
EM countries rely heavily on foreign-denominated debt, which creates significant liquidity and solvency risk and leaves EMs exposed to sudden shifts in global risk appetites
EM debt investors may want to be wary of Turkey, the Middle East and Africa, but Russia and Brazil could be better positioned to pay their debt obligations
EM equity valuations are far below their historical average – which implies attractive long-term investment opportunities
Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.
The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted.
This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations. This communication's sole purpose is to inform and does not under any circumstance constitute promotion or publicity of Allianz Global Investors products and/or services in Colombia or to Colombian residents pursuant to part 4 of Decree 2555 of 2010. This communication does not in any way aim to directly or indirectly initiate the purchase of a product or the provision of a service offered by Allianz Global Investors. Via reception of his document, each resident in Colombia acknowledges and accepts to have contacted Allianz Global Investors via their own initiative and that the communication under no circumstances does not arise from any promotional or marketing activities carried out by Allianz Global Investors. Colombian residents accept that accessing any type of social network page of Allianz Global Investors is done under their own responsibility and initiative and are aware that they may access specific information on the products and services of Allianz Global Investors. This communication is strictly private and confidential and may not be reproduced. This communication does not constitute a public offer of securities in Colombia pursuant to the public offer regulation set forth in Decree 2555 of 2010. This communication and the information provided herein should not be considered a solicitation or an offer by Allianz Global Investors or its affiliates to provide any financial products in Brazil, Panama, Peru and Uruguay. In Australia, this material is presented by Allianz Global Investors Asia Pacific Limited (“AllianzGI AP”) and is intended for the use of investment consultants and other institutional/professional investors only, and is not directed to the public or individual retail investors. AllianzGI AP is not licensed to provide financial services to retail clients in Australia. AllianzGI AP (Australian Registered Body Number 160 464 200) is exempt from the requirement to hold an Australian Foreign Financial Service License under the Corporations Act 2001 (Cth) pursuant to ASIC Class Order (CO 03/1103) with respect to the provision of financial services to wholesale clients only. AllianzGI AP is licensed and regulated by Hong Kong Securities and Futures Commission under Hong Kong laws, which differ from Australian laws.
This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors Distributors LLC, distributor registered with FINRA, is affiliated with Allianz Global Investors U.S. LLC; Allianz Global Investors GmbH, an investment company in Germany, authorised by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors (Schweiz) AG; Allianz Global Investors Asia Pacific Ltd, licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd, regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; Allianz Global Investors Japan Co, Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424, Member of Japan Investment Advisers Association and Investment Trust Association, Japan]; and Allianz Global Investors Taiwan Ltd, licensed by Financial Supervisory Commission in Taiwan.