The energy sector is the weakest performing MSCI sub-sector this year, down 40%.
The MSCI World Energy Index is dominated by oil and natural gas companies and the performance reflects the dramatic impact of Covid-19 lockdowns on global transportation and manufacturing, bringing oil demand down about 25% in April.
Add in an oil supply surge from Saudi Arabia (after the failed March OPEC meeting) and it is not surprising that the oil-oriented index has been so weak.
However, the index is a partial representation of the broader global energy theme.
While oil represents around one-third of world energy demand, it is worth remembering that coal still represents 27%, natural gas represents 24% and renewable sources (including wind, solar, biomass and geothermal) represent 4%.
Considering these various energy sources, we believe that the weakness in 'broader' energy equities across the board might provide a number of short term cyclical and long term structural investment opportunities.
Too little, too late
Firstly, to deal with crude oil and the cyclical opportunity that may be evolving here in the oil-oriented equities.
Just a month after their failed meeting in March, over the Easter weekend OPEC+ agreed to a headline cut of 9.7m b/day of oil production in an effort to defend oil prices against current demand weakness.
The devil, as ever, is in the detail and we believe that actual production cuts are likely to be significantly smaller than the headlines imply, potentially as little as 5m b/day of actual voluntary supply cuts.
Most likely, this will be too little, too late to defend the physical oil market in the near term as global oil inventory levels reach maximum operable levels in the next few weeks.
If oil storage gets full, it will be quite logical for some producers to pay shippers to take away their crude oil rather than them suffer the one-off costs or long term degradation caused by shutting in their production.
This is the first time in my career that I have considered the potential for negative benchmark crude oil prices.
(This article was submitted prior to benchmark crude oil prices going negative on 20 April.)
However, looking longer term, the agreement gives us confidence that OPEC is looking to defend oil prices and that a journey to rebalancing has begun.
The agreement extends for two years; it is longer and larger in duration than most had been expecting. This gives us confidence that the organisation has a strong desire to support prices through a potentially extended period of demand loss.
The forced shut-ins and capital expenditure reductions that are happening now will cause long term degradation in non-OPEC production capacity. This could be the catalyst for 'resetting' the cycle.
There is a lot to happen yet but, with oil and gas-oriented equities 'pricing in' a long term oil price of only $40/bl or so, there is a sizeable opportunity should OPEC regain control and manage prices back to their preferred level of US$60-70/bl.