Oil and Gas

Investors Run From Oil to Renewables

Last week, I wrote about the nightmare unfolding in the crude oil sector.

Due to COVID-19, millions of commuters are staying home. And oil companies are going to be the biggest losers.

Investors are already running away from the sector in droves.

The big question is, where is the smart money going?

Horrifying Times

Over the last five years, 215 oil and gas producers have filed for bankruptcy. And they had more than $129 billion in debt.

But that’s just the beginning. With COVID-19 in control, more hurt is coming.

Let’s get up to speed on what’s transpired in the last week.

Stay-at-home orders have resulted in a drop in global crude oil demand of an estimated 30 million barrels per day (bpd). That’s why I wrote that oil could plunge to $5 per barrel if countries kept overproducing.

And last Thursday, we learned that OPEC+ (OPEC countries plus Russia) agreed to a historic production cut of 10 million bpd in May and June. That’s about 10% of global supply.

Saudi Arabia is cutting 3.3 million bpd, and Russia is cutting 2 million bpd. Normally, that would send oil prices through the roof, and prices did stage a brief rally after the announcement.

But as we are all painfully aware, these are anything but normal times. The skittish markets didn’t like that deal.

I’m not surprised. The markets are looking for cuts of at least twice that size.

OPEC Secretary General Mohammed Barkindo summed up the glum situation this way: “The supply and demand fundamentals are horrifying.”

The Storage Bubble

The world has experienced a massive demand drop in crude. But producers are still pumping, and all of that oil has to go somewhere.

The U.S. has about 599.6 million barrels’ worth of commercial storage capacity. The highest level ever recorded was 535.5 million barrels back in March 2017.

This past March showed the second-largest crude stockpile build of 13.8 million barrels. That raised U.S. crude inventories to 469.1 million barrels, just 66.4 million below 2017’s record level.

Another option for U.S. storage is America’s Strategic Petroleum Reserve. At the end of March, it contained 635 million barrels.

It has the capacity to store another 78.5 million barrels. President Trump ordered Secretary of Energy Dan Brouillette to fill it.

However, Trump needs Congress to authorize that action. It has yet to do so.

Refiners are also dialing back throughput rates consistent with the massive drop in demand.

That’s going to cause even more crude to back up. If April refinery rates are cut by 50% (a very real possibility), as much as 6 million bpd of production could be stranded.

That much additional production will fill what little excess storage we have in a matter of months. With nowhere else to put excess crude, U.S. producers will have to dial back production.

That will hurt cash flows and send many U.S. producers into bankruptcy.

Where’s the Smart Money Going?

During these last few months, investors have been running for the exit.
Energy Select Sector Chart
But where are they taking their money? In a word, renewables.

The world has been slowly but steadily embarking on a move to decarbonize. Even oil companies like BP (NYSE: BP), Royal Dutch Shell (NYSE: RDS-A) and Total SA (NYSE: TOT) are diversifying into renewable energy.

Up until the COVID-19 virus hit, their progress was relatively slow. Today, oil and gas companies account for a paltry 2% of renewable investments.

Historically, their low level of participation in the sector was due to much lower returns.

But that’s no longer the case with WTI crude trading at $22.76 per barrel. Today, the returns from renewable projects look much better than those from oil and gas.

And renewable projects carry much less risk. No wonder the “smart money” is moving into the sector by the billions.

The bottom line is this: Investments in renewables have the best return on investment (ROI) in the energy sector. Solar, after a slow and rocky start, now has an industry-leading ROI.

The price of solar energy systems has dropped every quarter for the last 10 years. In the past five years, utility-scale solar energy costs have plunged nearly 400% and are now cheaper than coal and gas.

I’ll be sure to keep you updated on these developments, as well as any future investment opportunities.

Stay safe and healthy,

Dave