M&G: low oil price benefits airlines

Randeep Somel, Director of Global Equities in the M&G Equity team

In the history of the oil market, the 20th April 2020 will be a notable day. While we have become familiar with a volatile oil price, we have now seen the sharpest single day decline that has led to oil contracts trading at negative values for the first time.

Randeep Somel

The consistent increase in the oil supply since the advent of hydraulic fracturing (‘fracking’) has meant supply has been running ahead of demand for some time. The big producers, notably OPEC (and latterly OPEC+) have had many attempts to curtail production but their attempts have not been successful.

The sheer drop in demand due to economic impact of COVID-19 is unprecedented. Never in the history of the oil market has demand come to a halt as we are currently seeing. While no production can be economically feasible at such low oil prices, it is not so easy simply to switch off production from large oil wells. Shutdowns performed in a safe and sustainable manner take time.

So far only West Texas Intermediate (WTI), the North American oil market has had such a large surplus that the WTI price hit negative $40 at one point yesterday. The crude oil that is being produced needs to find a home and there are only so many storage facilities. As these facilities continue to fill up, the oil must be shipped further and further afield, and the buyers want compensation for that. European Brent is hovering around $20 per barrel, the abundance of supply is not as acute, but as the economies remain on partial shutdown and North American oil continues to look for a new home, expect European prices to remain pressured.

Production should continue to fall at these price levels and the excess supply should eventually clear, but we need economic activity to pick up again to see a more stable oil price. The reaction in the oil majors has not been very extreme, the assumption being that oil prices cannot remain this low for long without the market clearing.

A low oil price is good for consumers, as well as for those that still need to purchase oil. It also benefits oil importing countries as a large input cost of the economy has reduced so dramatically. The airline industry which would normally be very strong with such a low oil price is unfortunately unable to take advantage of the current situation.