What No One Is Telling You about the Energy Sector

Wednesday, 22 April 2020
Melbourne, Australia
By Greg Canavan

In Monday’s Insider, I pointed out the underperformance of banks and oil. With these two crucial sectors showing no signs of recovery, I wrote, the fundamentals supporting a market rebound remained weak.

The next day, US oil prices collapsed into deeply negative territory. That was a function of the expiry of near-term futures contracts, but even now, the US oil price is just US$10 a barrel.

To say there is a glut is missing the point. With the global economy shutdown, there is simply no demand. No amount of production cuts can fix the problem.

It’s not only the heavily oversupplied US market facing a crunch. The international oil price benchmark, Brent Crude fell 24% overnight. It closed the session at US$19.33, the lowest price in nearly 19 years.

Even if the global economy slowly gets back to work in the next month or so, international travel will be the last thing to recover.

Global jet fuel demand equates to around 8% of the world’s daily crude oil consumption. According to the London-based Facts Global Energy (FGE), jet fuel demand could plunge up to 70%.

It all sounds very ugly.

But let’s not jump on the ‘end of energy’ bandwagon.

Yes it looks grim, but you don’t get potentially outstanding opportunities during a time of rainbows and lollipops.

Of course, I don’t know which specific energy companies will survive and prosper in the years ahead. You really need to do you homework on that. In short, it’s the lowest cost producers who will survive.

But from a sector perspective, here’s what I find interesting…

While the US oil price collapsed into negative territory, and Brent Crude fell to a 19-year low, the ASX 200 Energy Index [ASX:XEJ] is well off its lows from 23 March.

You can see this clearly in the chart below. The chart doesn’t show today’s move, but at time of writing XEJ was only down 1.3%.

The Insider

Source: Optuma

This chart tells you that A LOT of bad news was in the price during the panic low of 23 March. The fact that the US oil price went negative and Brent Crude is near 19-year lows, yet the energy index is not making new lows, is a positive sign.

I’m not suggesting you go and load up on energy stocks. It’s clearly going to take some time to work through the current over supply/under demand situation.

But if you’re thinking of throwing in the towel and getting rid of any energy stocks you own, you might want to think again. You might be doing so close to the bottom.

From here, I would look for energy stocks to make a ‘higher low’. That is, put in a bottom ABOVE the 23 March low. That would be a positive sign.

Divergences like this are important signals. They can be bullish or bearish. The fact that there is so much negative news out on oil right now, yet energy stocks haven’t made new lows along with the oil price, is an encouraging sign.

It’s the same situation with the iShares S&P Global Energy Index ETF [AMEX:IXC], as you can see below…

The Insider

Source: Optuma

So the message here is that global oil stocks may have bottomed. That is, the market, either in its wisdom or eternal hopefulness, sees better times ahead.

That may be hard to fathom right now, but the market doesn’t care for your opinion.

It’s the same in the boarder market. There is a lot of pessimism and worry out there, yet the market is trading well above its lows from 23 March. Even today, the market opened down sharply, but spent the morning and early afternoon recovering that ground.

The bearish mood is well encapsulated by Robert Gottliebsen’s article in The Australian today:

The latest falls in global and Australian sharemarkets show we are starting to understand the deeper implications of the big fall in oil prices. The oil price slump is merely symptom of a glut of just about every non-food item you can think of, apart medical equipment, as well as rapidly falling inflation.

The Australian population is in deep shock.

Reserve Bank governor Philip Lowe says we are facing the biggest fall since the depression. While that’s true, as I pointed out on Friday, the speed of this decline has no parallel since Federation.

Lowe believes that if restrictions are eased we could expect the economy to begin its bounce-back in the September quarter and for that bounce-back to strengthen from there.

“If this is how things play out, the economy could be expected to grow very strongly next year, with GDP growth of perhaps 6–7 per cent, after a fall of around 6 per cent this year”, Lowe says.

I hope you were right Philip, but I fear you are wrong. Falls of this magnitude don’t snap back and take a long time to recover.

Gottliebsen goes on to point out many reasons why we should be concerned:

  • China no longer sending students in there thousands to fill our universities.
  • Immigration grinding to a halt and hitting the housing construction market.
  • Tourism drying up and hitting all associated sectors.
  • China not constructing its way out of its slowdown, thus not supporting commodity prices like it did in 2009/10.

These are all legitimate concerns.

One thing to keep in mind though is that, during times of worry and fear, we tend to lose our imagination for seeing the good things to come out of a crisis.

For example, the loss of huge numbers of international students might hit the economy in the short term, but it will strip out a lot of waste and bureaucracy that has nothing to do with delivering better education outcomes.

And the strained relations with China might see us rethink some of our crucial manufacturing production. After all, with a dollar in the 60 US cent range, we’re more competitive on that front than we have been in the past.

Anyway, the point is, there is plenty of good that can come from all this. With the right reforms around tax and regulation, Australia could come out of this very nicely.

Cheers,
Greg Canavan

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