Crude Oil Drinks a Corona (catches a virus)

This is reminiscent of late 2014 when Saudi took aim at the US Shale industry, creating an all-out price war which led to oil prices falling from US$100+/bbl to US$30/bbl a year later. The energy industry has adjusted its cost base and mostly survived that fall but it’s in for another fight as Russia has indicated it will continue to pump as planned. For Canada, this is another blow to Alberta and could push the province into a recession in short order.

The oil market has been pushed into turmoil with the reversal of Saudi Arabia to push through an OPEC production cut after failing to secure Russian cooperation. The rise of shale oil production in the U.S. more than doubled its total output rate over the last 7 years, becoming the world’s largest producer, squeezing the finances of both Saudi Arabia and Russia. Case in point, In Saudi, GDP per capita has dropped 20% to US$20,000 and stagnated in Russia, after growing healthily through the earlier years of the Putin Regime. Saudi’s answer was to encourage OPEC and the other countries dependant on production to cut production to hold prices. This broke down over the weekend with Russia calling Saudi’s bluff. In return, Saudi will pump another 2-4 million barrels a day into the 100 million a day market.

In a more normal environment, this type of move would be celebrated, especially by those of us who remember the recessions and inflation spike of the 1970s and early 1980s which was partly caused by the formation of OPEC and the increase of crude oil prices from US$3/ to US$40/bbl. 40 years later, deflation is the primary concern of policymakers and lower input costs will not help Central Banks reach their inflation targets.

As the Coronavirus continues to impact the travel and tourism industry, the divided response from different governments entails a different set of risks. Gold standards are found in South Korea and Singapore, where aggressive use of widespread testing (South Korea has tested 190k people) has identified the majority of cases, providing the opportunity to isolate and quarantine people most likely to spread the virus. New case growth is slowing, and it appears to be coming under control in these countries. On the opposite end, the U.S. has been slow to roll out testing and the downplaying of risk by top officials is creating public distrust. U.S. numbers remain low simply due to a lack of testing, and as these efforts inevitably ramp up, expect a surge in U.S. cases. Trump’s re-election hangs in the balance with betting markets now pricing in a 50/50 chance versus likely challenger Joe Biden.

Covid 19 is an awful disease, that disproportionately affects the elderly, but we have heard cases of healthy adults suffering through difficult cases. There remains insufficient and conflicting data to fully understand the impact on both human health and global economies. This uncertainty is the backbone of the market volatility in the last three weeks. However, we still do not forecast any wide systemic risk to markets like the banking collapse in 2008 or the technology bubble of 2000 where massive amounts of wealth ‘vanished’ seemingly overnight. As the stimulating effects of low-interest rates and Government/Central Bank actions occur and we expect a strong recovery in demand once virus fears subside (which they will).

CONCLUSION

In our portfolio, we are light on oil-related company holdings. Only Enbridge in our Global Growth Fund. Our Dividend Growth Portfolio also contains Enbridge as well as Interpipe, both of which should be able to maintain their dividends. We will look at our two smaller companies, Cardinal Energy and High Artic Energy Services where dividends are in danger of elimination.

We still expect the virus to dissipate sometime this spring and generally witness a return to normal business activity over the balance of 2020, the exception being travel-related activity.

At this stage, we believe the fear of fear itself is in control of the volatility. We will continue to manage our portfolios as we always have, monitoring and rebalancing our portfolios where we see relative opportunity.