We haven’t been writing a lot lately because work from home is hard.
Somewhat amusing, I was supposed to meet a friend somewhere in December and we decided on Wuhan. She later decided that she did not want to meet up and went to California. My AMEX concierge then cancelled my flight to Wuhan. If I were in quarantine in Wuhan, we would probably have more articles here.
For the first time ever I was correct in making a call on some asset class as WTI futures fell below zero.
Everyone who asked me about whether or not they should double down on USO ended up saving some money, so now I have accumulated a number of steak dinner credits that I intend to never cash (because I do not want to see any of you).
These are crazy times we live in – but wanted to note some observations. While oil has been a range bound story, gas has been an unloved cousin in North America because of the relative abundance versus limited demand.
Natural Gas post-COVID-19
Gas fired power plants, petrochemicals and limited LNG outlets all around the Gulf Coast (far away from the demand center that is Asia) have not been able to suck up all of the massive quantities of associated gas (gas produced as a byproduct to oil and liquids production) that have flooded the markets and depressed Henry Hub. 30% of Lower 48 gas production is associated gas.
With shale oil producers poised to shut in millions of barrels of production, gas supply is supposed to come off to the tune of 12 – 15 billion cubic feet a day. 2021 gas futures have rocketed (and from a low base as gas was trading around $3 per MMBtu) up 20% while long depressed gas equities are the sole bright light in energy equities.
While WTI plummeted to unforeseen levels, people were wondering whether or not that affected overseas oil – or Brent crude. We can probably expect the same thesis to play out, although it will take more time because Brent is unencumbered while WTI is a regional, landlocked benchmark.
Nonetheless, storage is filling – notwithstanding various speculators being pragmatic and storing oil in just about anything they can find to capture the current contango (railcars, pipelines, mom’s apartment). When storage gets tight, could Brent go the same way as WTI? I don’t think I can make two correct calls in a row so I will hold off here.
Where is Oil Going After the Shutdown?
The argument against oil prices continuing to fall is based on demand picking back up from lockdowns being lifted. In China, things are already back to normal while countries such as Singapore and Japan are shutting down again.
A V-shaped or even U-shaped recovery seems optimistic. For one, we have had a low level of adherence in the USA. Two, just because you are allowed to get on a plane does not mean the more prudent amongst us will – exacerbated by the first point. As such, it will take a long time for certain consumption patterns to come back – and I suspect some forms of consumption will never come back.
In addition, there are a number of unresolved frictions that may take time to smooth out. For one, consumer confidence is low and unemployment is high. For businesses to hire, they are going to need to know that they will earn the returns required to justify adding headcount. Everyone in investment banking is working from home now. Everyone hates it in week 6, but around week 7 people get used to it and people get used to food delivery. Even the long-time late or never adopters in grandma and grandpa are picking up the smartphone and figuring out how to use Deliveroo. For businesses that expect high foot traffic when this thing blows over they may be in for a nasty surprise.
Bankruptcies will be hard to sort out, and there will be numerous filings – both corporate and personal. Note the stories of Shake Shack and Ruths Chris (who do not make very good steaks despite the high ticket) qualifying for federal aid and relief via commercial banks while most small businesses have been denied. This is in the news and common anecdotally over my social media feeds and I am sure yours as well (if you have friends).
For all of the spending on healthcare on the back of COVID, there are a lot of unresolved questions pertaining to who will foot the bill. Although the White House markets widespread testing, cost waivers and everything else, the reality has been anything but.
USDCAD and Canada Economy Post-Coronavirus
Somewhat of a surprise but dollar Cad (USDCAD) has not strengthened as much despite the oil price being bad and the primary Canadian oil benchmark, Western Canadian Select being worse.
We wrote about a decoupling of the relationship between USDCAD and energy prices in the past, and we would expect that the relationship becomes less and less meaningful as oil & gas extraction becomes an increasingly smaller component of the Canadian economy. The Petrodollar is dying.
Canada is also going to discover in the next 10 years that it has been too dependent on the US in terms of trade and commerce. Canadian debtors were already on life support before the coronavirus in terms of living from paycheque to paycheque and unable to tolerate even a 25 bps rise in interest rates.
Most of Canadian net worth is tied up in real estate, which trades at inflated multiples to income relative to other countries. If there is a massive depression, we can see the house prices collapse while the debt (mortgages) owed to banks remains the same and homeowners underwater.
This means one of two things, a stagnant economy for multiple years or decades (see Japan’s lost decade) in a balance sheet recession as income goes towards debt service instead of growth, or more monetary policy solutions as the Bank of Canada prints money to inflate prices and erode the value of the debt.
Quantitative easing hurts the middle class but the wealthy stay wealthy as stocks are a reasonable inflation hedge. In theory gold should go up. I am holding a lot of gold.