Energy market commentary: May 2019

Data as of May 31, 2019 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.

Market volatility hits energy sector in May: May saw much of the energy sector trade down as financial market volatility took its toll on the space. The S&P 500 had its first down month of 2019, declining -6.35%, while a 38 bp decline in the 10-year U.S. Treasury yield signaled a broad risk-off shift. Midstream equities generally outperformed the rest of the energy sector as falling benchmark yields provided a tailwind for yield-oriented investments. HY Energy underperformed the broader high yield market, as spread widening outweighed any benefits of falling rates. S&P Energy was the laggard in the energy sector, falling -11.14% due to equity market weakness and falling crude oil prices.¹ Much of the market volatility can be attributed to U.S. trade tensions with China and, most recently, Mexico. Issues related to trade have dented sentiment around global growth and, by extension, global demand for energy. While much of 2019 has been about OPEC+ and its adherence to promised production cuts, the drop in crude prices in May was more reflective of growing uncertainties surrounding the global macroeconomic condition.

Oil prices: Another downturn or just a blip? Crude prices were sailing along for most of the month, with WTI just about flat as of May 21. The last week of the month brought heightened financial market volatility that hit not only stocks and interest rates but commodities as well, as WTI declined -15% over the last week of May.¹ So, what changed? The move can largely be explained by concerns about global demand. The IMF has cut 2019 GDP growth expectations for every advanced economy compared to last year, signaling a broad global deceleration.² Trade war escalation between the U.S., the world’s largest oil producer, and China, the world’s second-largest oil consumer, risks exacerbating these demand worries. From a supply perspective, while OPEC production was flat in May as Saudi Arabia largely replaced Iran’s production, the Saudis maintain that the 14-member group is committed to keeping cuts in place for at least the remainder of 2019. The question is whether Russia, which agreed to reduce production but only hit its target cut for the first time in May, will continue cooperating.¹ Russia’s GDP growth rate fell from 2.7% in Q4 2018 to 0.5% in Q1,³ which could pressure Moscow to increase production to aid the domestic economy. In all, May’s plunge in crude prices was driven by financial market volatility caused by global aggregate demand concerns. The supply environment remains generally accommodative for oil, which means crude may continue to trade with other risk assets for the time being.

Key takeaways

• Financial market volatility hit the energy sector in May.
• Declining interest rates helped yield-centric midstream outperform much of the equity market.
• Crude prices wavered with the rest of risk assets, though the supply story remains largely intact.