Driven by the collapse in demand for gasoline and jet fuel, the near-term outlook for oil pricing is poor. Prices may reflect continued distress on record declines in demand for transportation fuels. Nevertheless, Citi analysts expect that cuts in production (and likely access to storage in America’s strategic petroleum reserve storage) may begin to relieve the overhang. As economies turn back on, demand may also rise. Citi analysts expect a sharp reversal higher in crude oil pricing before 2020 ends, though only back to a lower-than-average level of US$40/bbl.
Caution and selectivity when investing in energy sector
In the bond markets, even high quality issuers with good balance sheets may face credit downgrades due to committed capital expenditures and poor cash flow.
While spreads have narrowed from the wides of March due to Fed intervention, the energy-related default rate was 5.9% globally as of February 2020; 50% of all high yield (HY) energy issuers trade at 70% or less of par. Thus, Citi analysts expect more distress, defaults and price deterioration for many companies.
Citi analysts also advise caution when considering the debt of Middle East and smaller Latin America emerging markets countries that are heavily dependent on energy. This includes the debt of companies that are backed by these governments.
While the stronger energy companies globally may eventually bounce-back, and potentially deliver strong returns in that rally, the broader sector seems likely to stay far below the pre COVID-19 level. The already depressed sector’s valuations may not return to prior highs as transportation fuel demand could remain low until there is a COVID-19 vaccine. The sector already suffered from improving fundamentals for alternative energy, such as solar-powered batteries, reducing pre COVID-19 demand by more than 1% per year.
Potential beneficiaries in Logistics and E-Commerce
Energy consumers in Asia and other importing countries for one; the beneficiaries could have lower costs and capital balances.
Another winner are logistics and e-commerce that together are displacing traditional retailers even faster as we face the impact of COVID-19. In this case, Citi analysts see the shift to e-commerce and the improvement in delivery of everything as a permanent change (and benefit) associated with the health crisis.