Today we are pleased to launch our new, recurring blog segment Questions of the Week. Each entry will focus on providing in depth answers to some of the questions we have received from clients over the past week. Today’s entry focuses on the recent declines in the price of oil, the causes of those declines and the outlook for energy going forward. Future posts will cover questions related to the changes to this year’s Registered Retirement Income Fund (RRIF) minimum payments and the outlook for the Canadian banks, among others. If you have any questions you would like to see answered in a future post, please send them to using our contact email.

 

Question: What has happened to the price of oil this week? Why has this happened and what is the long-term outlook for energy?

 

Oil has not fared well in 2020. From its highs in early January, the price of a barrel of oil has declined by more than 70%. For context, the Toronto stock index has declined approximately 16% over the same period. The double shock of the decrease in demand due to Covid-19 restrictions and an increase in production and supply has left the price of oil at about the same level it was in the late 19th century, back when its primary use was lighting. We will look at each of these factors in greater detail, then examine what this means for the energy sector as a whole.

 

Declining Demand

 

As countries around the world have moved through the various stages of Covid-19 lockdown, demand for oil and oil products has decreased substantially. People are not traveling unless it is required. Air travel is down by approximately 90% from one year ago. Cars are sitting in driveways with the same tank of gas they had back in March. While this slowdown has been beneficial in the fight against climate change (data shows significant decreases in air pollution around the world), it has put significant pressure on an oil market that was already struggling with flattening demand. On top of the uncertainty caused by Covid-19 measures, mid-March saw the dissolution of the OPEC+ agreement to limit global production of oil. Russia and Saudi Arabia, two major OPEC+ powers, failed to come to terms on production cuts. As a result, former members of OPEC+ were freed to produce as much oil as they wished, increasing potential supply and putting further downwards pressure on prices.

 

Storage Wars

 

While OPEC+ did eventually reach an agreement to limit production this month, the damage had already been done in terms of both physical supply and investor sentiment. As supplies increased over the past six weeks, available storage decreased. With little global capacity to store oil, traders were left with the very real possibility that they may buy a barrel of oil and have nowhere to put it except their own bathtubs, which is neither a viable long-term solution nor hygienic. This has put further downward pressure on both demand and prices. This trend culminated with the price of a barrel of oil trading to negative levels for the first time in history on April 20th. Effectively, oil traders were paying counterparties to take barrels off their hands.

 

Outlook

 

This unprecedented decline has sent a shock through energy markets. While prices have recovered somewhat and are once again trading on the right side of zero, it is likely that oil will remain depressed in the coming months. We may see negative prices again as futures contracts expire each month and, assuming current travel restrictions remain in place, supply will continue to outstrip demand for the foreseeable future. In this environment, many oil producers and explorers will find themselves challenged. Companies operating in areas where oil naturally trades at a discount due to quality or accessibility (such as the Canadian oil sands) may be forced to suspend or shutter operations. Energy infrastructure companies, such as pipelines, should fare better, however negative sentiment will likely weigh on anything energy related in the near-term.

 

Next Steps

 

For investors who have exposure to energy related companies, now is a good time to review these holdings. There will likely be significant change in the sector in the coming years, as companies adapt to both recent events and long-term secular trends towards cleaner energy. We are always happy to discuss the outlook for individual companies, as well as ways to position your portfolio to adapt to the risks and opportunities presented by both current and long-term trends.

 

Thank you for taking the time to read our inaugural edition of Questions of the Week. We look forward to bringing you similar updates in the coming weeks. Stay tuned for our next post on the changes to this year's RRIF minimum payment, coming later this week.