The Covid-19 defaults have finally begun

What happens when you get six of the world’s foremost energy experts together to hash out the future of energy?

I’m not sure, to be honest. But we’re going to find out the hard way. The only question is whether you’ll join us early next week. Whether you’ll get a sneak peak of our energy future, before anyone else does.

Given what oil did for UK investors, I hope you can see what anticipating the future of energy might do for you…

But now, on to today’s investigation. We’ll start with the conclusion I’m going to reach.

Don’t believe the stockmarket.

Believe the oil price instead.

This chart shows the divergence, with the S&P 500 futures in… erm… lilac… and the oil price in orange.

Source: The Market Ear

While the US stockmarket is up, the oil price has continued the crash which began in January. A 21% plunge of the WTI price in today’s Asian trading piled on the pain and gave us new lows. The last time oil traded here was 21 years ago.


The latest round of panic selling is simple to explain. The world’s oil storage facilities have been filling up fast thanks to a simultaneous demand shock and supply glut. Covid-19 and OPEC can share the blame however they like.

The problem is that, if oil storage hits capacity, what happens next? What do you do when huge tankers full of oil are bound for ports with overflowing storage? And nobody is buying.

Well, there’s talk of negative oil prices. Sounds absurd, but we’re not far off according to Bloomberg: “Buyers in Texas are offering as little as $2 a barrel for some oil streams, raising the possibility that American producers may soon have to pay customers to take crude off their hands.” Last week I mentioned a negative bid for the type of oil used for asphalt.

So, do you see an economic recovery while oil prices are plunging 20% in a single day? Seems unlikely to me.

For now, the oil futures market is expecting a rapid recovery in the oil price. Oil for delivery in May is priced below $15, but June is priced above $23 and August above $30. This is called “contango” – a rising oil price in the future. But it’s more of a super contango with prices surging that fast.

Contango is a pain in the neck because it encourages those with oil in storage, often bought at much higher prices, to wait for higher prices in the future. Why sell now when prices will be higher next month?

It’s a great example of how the free market solves these problems – low prices encourage hoarding, which fixes the glut. Unfortunately for oil producers, the lack of turnover worsens the situation in the storage market, making a negative price possible soon.

Does the future higher oil price make oil companies a buy in the stockmarket? A 100% increase in oil prices is priced in, in a matter of months.

But it’s not just priced into oil markets. It’s priced into stocks too. Oil companies’ shares are assuming they’ll survive and recover. I’m not so sure they won’t go bust in the meantime. Nor that the higher oil prices will arrive in the future if companies don’t go bust in the meantime.

Things are escalating rather fast on that front. In September 2019, the Wall Street Journal reported that “Japan’s Mitsubishi Says Rogue Oil Trader Lost $320 Million”. Compare that to last week’s news – a tenfold increase in the problem.

Reuters had this headline about one of Asia’s largest oil traders: “Singapore oil trader Hin Leong owes $3.85 billion to banks”. Hin Leong means “prosperity” in Chinese, believe it or not. The firm now has 30 days protection from creditors, by which time a court will decide whether to grant a six-month extension on its debts. Given the founder of the oil trading firm has admitted to hiding losses for years, it seems unlikely it’ll get protection. profiled the body count in the US shale industry:

According to Reuters, a raft of big lenders including JPMorgan Chase & Co, Wells Fargo & Co, Bank of America Corp and Citigroup Inc, have kicked off the process of setting up independent companies that will take over operations at distressed oil and gas companies.

Whiting Petroleum Corp. (NYSE: WLL) became the first victim of the shale bust after it filed for Chapter 11 bankruptcy on April 1 with other beleaguered producers such as Chesapeake Energy Corp. (NYSE: CHK), Denbury Resources Inc. (NYSE: DNR) and Callon Petroleum Co (NYE: CPE), reportedly having hired debt advisers, too.

This is precisely how the Asian financial crisis began in the 90s. A fairly minor Thai property developer defaulted on its obligations. Next minute, international banks and entire countries were going bust.

Don’t watch snowflakes if you’re looking for avalanches. Watch the mountainside.

The Russians still remember the Asian financial crisis well, apparently. Their government went bust back then. So, instead of just hoarding toilet paper and food, the Russians hoarded cash at the height of Covid-19. They know how financial crises appear at the ATM before you hear about them in the news. Bloomberg had the figures:

About 1 trillion rubles ($13.6 billion) has been issued from cash machines and bank branches since the beginning of March, more than during the whole of last year, central bank data show.

Of course, it’s not just the oil market that’s breaking down thanks to Covid-19. I’ve been hunting for the butterfly which flaps its wings, creating a financial crisis on the other side of the world. Italy and oil are my top two hunting grounds.

But US mortgage defaults could shape up far worse than those which triggered the 2008 financial crisis. Debt ratings agency Moody’s has a scenario where 30% of US borrowers could stop paying their mortgages. That’s triple the 2009 peak. In the corporate world, Moody’s list of distressed is already at all-time highs – 311 to 2009’s 291 peak.

Busts like the ones coming to the oil markets can trigger wider stockmarket carnage – the whole point of the butterfly effect and the avalanche metaphor. And crashes are worth avoiding, if you can.

But that’s only half the game in an era where the FTSE 100 goes nowhere for more than 20 years. The other half is to figure out what’s booming. Not just where to avoid, but what to invest in.

While oil companies go bust, what’ll outperform the market?

My colleagues James Allen and Kit Winder are putting together the answer for you right now. They’re asking themselves what’ll replace oil as the future source of energy. And the oil price smash has given away something fascinating about the energy sources they’ve highlighted.

Historically speaking, an oil price crash undermines other forms of energy by making oil cheaper. But this time, there’s a decoupling of the markets that James and Kit focus on. They haven’t crashed alongside the oil price. They are now Beyond Oil.

Find out more by signing up to their event here. Just remember to keep one eye on the oil market in the meantime.

Nick Hubble
Editor, Southbank Investment Research

Category: Energy

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