Oil shoots higher – have we seen the bottom for the big oil companies?

Just a few days ago everyone was worried about negative oil prices. Now, the market has turned upwards. John Stepek explains what’s behind the rise and what it means for the oil majors.

Oil tankers are being used for storage © Getty

At the start of the week, we were talking about the oil price potentially turning negative. Naturally, we’re now ending the week with the oil price rocketing higher.

So what happened in a week – and is this the turn for the oil price?

At the start of the week, everyone was talking about the oil price turning negative. There was so much oil hitting the market that all the storage space that could be found was being filled to the brim. As Tom Holland of Gavekal points out, so much of the stuff is being stored in stationary oil tankers right now that “charter rates for tankers have doubled and doubled again in the last month."

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It costs money to shut down an oil well and then restart it up. So in theory, you could get to the point where oil producers were still better off pumping the stuff out and paying someone to take it off their hands.

Thus the idea that you’d get negative oil prices.

Now we are in a pretty serious situation. Vast chunks of the global economy have shut down and we’re still not sure if and when it’ll reopen for business (Singapore has just gone into full lockdown now apparently, which makes the whole “this’ll pass in a few months” idea look a little less hopeful).

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Meanwhile the Saudis and the Russians chose this point to declare an oil price war (which to be fair, if their goal is to wipe out US shale production, this is the best time to give it a crack).

So it’s hard to envisage a more drastic scenario for oil prices.

Why oil shot higher yesterday

That said – when you’re talking seriously about what is still one of the world’s most valuable (as in necessary, rather than price wise) commodities being literally given away by producers, you have to wonder about where we are sentiment-wise.

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When everyone is tilted to one side or another in a market, the fundamentals don’t really matter – it really doesn’t take very much to drive prices in the opposite direction. And that’s what happened yesterday.

President Donald Trump tweeted that he’d spoken to Saudi Arabia and that the Saudis had spoken to the Russians, and that they were planning to cut production.

His specific line on the amount of production was somewhat far-fetched (ten to 15 million barrels a day), so as with most of Trump’s tweets, the news was worth taking with a pinch of salt. And Russia promptly denied any such discussion (also worth taking with a pinch of salt, of course).

However, Trump is set to talk to the US oil industry today – maybe he’ll be softening them up to cooperate on any discussion of cuts. And on Monday, the Opec-plus cartel (ie, Saudi Arabia and Russia) are planning to meet up virtually to discuss cuts. So we may well be at the point where the all out “pump and be damned” phase is passing.

The oil majors look like they’ve seen a bottom

So what happens now?

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The oil price has managed to hold on to a good chunk of the gains it made when it rebounded on Trump’s tweet. Will it go much higher from here? Your guess is as good as mine. The demand picture remains incredibly ugly, so it really depends on the supply side.

When we get to the point where no one will take the oil off producers’ hands, you have to bet that they will cut production. So it seems unlikely that there won’t be some sort of agreement on production cuts on Monday.

That isn’t likely to make the sort of difference that would send oil a lot higher from here. But it might take negative prices off the table. And given the massive negativity in the sector there’s probably more risk on the upside than on the downside.

As Holland puts it, for producers, “while the coming quarters will be extremely painful, they will not be fatal.” Some US shale producers will go to the wall, but some hedged their production at much higher costs and could even benefit now.

So what’s the upshot for you as an investor? The more stabilisation in oil production we see, the more likely it is that the big players – the oil majors – won’t need to cut their dividends.

That in turn makes the likes of Shell and Exxon etc. look more appealing. They have rebounded solidly from their lows but if you’re holding or considering buying, it’s still one of the sectors I’d still feel relatively comfortable about investing in at this level.

We have more on oil prices in the latest edition of MoneyWeek magazine – get your first six issues free here.

Until tomorrow,

John Stepek

Executive editor, MoneyWeek




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