The overall fall in the oil price is further evidence of how economies have grounded to a halt because of covid-19 and the current lack of demand for oil in the market. At the same time, US oil production has continued. Producers are now at a stage where they are quickly running out of tankers to store oil.
There are some important technical factors at play here, the US WTI price is linked to the next futures contract (an agreement to buy or sell an asset at a future date at an agreed-upon price) and the May WTI future last day of trading was yesterday (Tuesday 21st). WTI May-dated futures contracts require futures buyers to take delivery of the oil in the city of Cushing, Oklahoma. Given that there is little if any storage space available in that location the traders are ditching their contracts.
Market attention now turns to the WTI contract for June delivery, to see if the pattern persists. The June contract is trading at $11, supported by hopes that the worst of the demand erosion could ease by then, if lockdowns and travel bans are loosened.
Brent is currently already trading on the June futures contract. This is one of the reasons why the price falls haven’t been as extreme for the European benchmark. As well as this, Brent Oil futures contracts can be delivered offshore to a variety of locations. If there isn’t enough storage in one place, then the oil can be delivered elsewhere – whereas the US WTI futures contracts are landlocked in Cushing, Oklahoma – which is weeks away from running out of capacity.
The move in oil prices, highlights how weak the global economic environment is at present, the impact of these moves were felt in global stock markets and they are weaker yesterday. Despite these concerns equity markets have been mostly stronger over the last week.
Specifically to the UK equity market, BP and Royal Dutch Shell are big constituents of the FTSE 100 and both are seeing share prices lower this week – which will be negatively impacting portfolio directly invested in these names and also UK equity funds. Both BP and Royal Dutch Shell tend to be big holdings in UK equity, dividend orientated products, because of the high historic dividend yields on offer. These UK equity income funds may have been harder hit by the moves this week, because of the oil price. Both companies now have a dividend yield of over 11 per cent – which is extremely high versus their own history and suggests a lot of bad news is baked into the share price already. However, this dividend yield may not be fully received, if they look to cut or pause the dividend, as other businesses have done during the current market environment.
In summary, a negative short-term period for funds and portfolios overly exposed to the oil market, as you would expect, but the overall market has been relatively resilient this week despite these concerns.
Source: Alpha Terminal (22/04/2020)
Chief Investment Officer
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