Oil prices caused rapid market decline, but why?
The drop in crude oil prices over the last few days has been prompted by both:
a) Investor concerns over the anticipated short-term demand disruption (i.e. over supply) due to the impact of the coronavirus on the global economy, and
b) The dispute that recently surfaced between Saudi Arabia (OPEC) and Russia regarding crude oil production cuts.
Coronavirus concerns have been part of the conversation for a number of weeks, but it is our opinion that the dispute between Saudi Arabia and Russia was the primary cause of the dramatic market fluctuations recently witnessed.
Russia and Saudi Arabia (OPEC) are currently at odds over additional crude oil production cuts, and it is for this reason that Saudi Arabia has launched a price war against Russia. The price war started when Russia rejected a proposal from OPEC leaders for an additional production cut of 1.5 million barrels of crude oil per day. Instead, Russia proposed keeping the current deal through the June 2020 meeting, which meant only 1.7 million barrels of crude oil per day in production cuts that was implemented in January 2017. Because of this impasse, OPEC+ (Russia + OPEC) will be able to produce as much crude oil as they want, starting on April 1st. A deal can still be reached before this date, but the concern about not only removing the current production cuts but also allowing unlimited production only exacerbates the current concern about over supply given the coronavirus demand disruptions. There is no way to predict when the dispute will be mediated, but given the severe market response to this news, both primary players are most likely evaluating options currently.
With regard to the energy market, particularly the midstream market, investors may want to consider a more defensive posture toward commodity-sensitive names and companies positioned closer to the wellhead (i.e. gatherers and processors), and increased exposure to overly discounted natural gas companies—which may benefit from the decline (or flattening) of crude oil production (e.g. less associated gas supply). This may help to alleviate ongoing concerns regarding the impact of crude oil price volatility. But, as always, investors should continue to monitor market developments and attempt to maintain a diversified portfolio to help better navigate through this tumultuous period.
This material represents an assessment of the market environment as at a specific date; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any issuer or security in particular.
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