Energy market commentary: July 2020

Data as of July 31, 2020 unless otherwise noted.

Performance (total returns)

Performance data quoted represents past performance and is no guarantee of future results. An investment cannot be made directly in an index.

Energy sector rebound put on pause: In the same way many economic indicators in the U.S. have plateaued amid persistent coronavirus outbreaks, the rebound in most parts of the energy markets has lost steam over the past couple months. Large-cap energy equities have been the worst-performing area of the S&P 500 since the start of June, and stalwarts like Exxon Mobil and Chevron confirmed investor fears with Q2 earnings revealing the firms’ worst financial results in decades. Quarterly earnings reports in midstream have been more resilient thanks to the sector’s stable cash flow profile, though performance continues to struggle along with the rest of the energy space. The AMZX is still 40.3% below its 2020 high, while the AMEIX remains 32.4% below its peak level. High yield energy bonds have been the outlier in the sector, returning 5.7% in July. Energy spreads tightened to 836 bps to end the month, the lowest since the start of the pandemic, as the Fed continues to support credit markets.¹

It’s all uphill from here: Global crude production likely hit a nadir in June or July and will begin to increase starting in August. As the COVID-19 pandemic wreaked havoc on world economies, OPEC+, which in normal times controls about 40% of global crude supply, made unprecedented supply cuts in support of oil prices.² Meanwhile, low prices had a large impact on private sector production in North America, with output in the U.S. and Canada dropping by 19% and 22%, respectively, from March to June. However, as economies have begun to reopen, there are signs that supply is unlikely to fall any further in coming months. OPEC+ production rose slightly in July and the bloc has promised to add back around 1.4 MMbpd of the original 9.7 MMbpd cut beginning in August. In the U.S., production appears to have troughed in mid-June, as crude supply rose slightly in July and active rig counts are no longer declining. Clearly, the rapid drop in supply successfully stabilized prices. Now, stable prices are likely to lead to increased production. While this is a positive for governments and businesses in desperate need of revenue, the increased supply must be equaled by improving demand, otherwise the deficit will weigh on prices again. This is the dilemma faced by the world’s energy producers – ultimately, their fate will be dictated by the path of the virus and its impact on consumption.¹

Key takeaways

• The rebound in energy markets has sputtered over the past two months.
• Global crude production is likely to increase in the coming months, which could test oil prices previously stabilized by unprecedented supply cuts.