April 21, 2020
April 21, 2020 | Adviser News
Global Thematic Team: comments from Lazard on COVID-19
Negative short-term oil prices are not sustainable
An oil price futures contract (the May contract for West Texas Intermediate futures, the benchmark for US crude prices) fell into negative territory for the first time ever on Monday (20 April) in the US. Measures designed to contain the spread of COVID-19 have constrained economic activity to such a degree that the continued supply of crude risks overwhelming storage capacity in the US.
The Zurich Investments Global Thematic Share Fund has direct exposure to oil of just under 4% as part of its ‘Energy Transitions’ theme. Lazard Asset Management’s Global Thematic team, which manages the Fund, has made the following observations:
Our Energy Transitions theme consists of companies which we believe can be part of the solution in delivering the world’s energy mix while solving for climate change goals. This energy mix is evolving towards lower-emission energy production in the form of natural gas and renewables but will still incorporate substantial demand for oil and oil-derived products for the foreseeable future. Within our theme, alongside exposure to the renewables supply chain, we own some names with exposure to the oil price, notably some large-cap integrated oil and gas companies.
In recent days and weeks near-term oil prices have come under incredible pressure due to two factors. The first is much weaker oil demand due to the Covid-19 pandemic and the second is excess supply resulting from the inability of OPEC+ (essentially OPEC and Russia) to sufficiently reduce supply. This demand-supply picture has been sustained for sufficient duration to fill storage facilities, resulting in a highly unusual situation where producers are actually paying customers to take oil off their hands. Near-term price moves will be exacerbated by speculative players – financial and derivative markets for oil are far larger than physical markets.
While we do not forecast commodity prices, we also think that current oil prices at the short end of the curve are unlikely to be sustained at these low levels. No company can make money at these prices longer-term, and countries that depend on oil exports to support social welfare programs cannot balance the books either. Supply will ultimately be reduced one way or another, and near-term oil prices will recover.
We are not concerned about the large-cap companies we hold in Energy Transitions which effectively have exposure to the longer end of the oil curve and an ability to withstand a prolonged period of low oil prices. Many of our companies are fully integrated and control their own distribution. All have robust balance sheets and diversified operations. We observe that companies have reacted very quickly to reign in capex and costs, as memories of the 2014-16 correction are still recent. The companies we own generate significant free cash flow, and we believe that even if dividends are suspended temporarily, their cash flow generation is sufficiently high to generate high returns to shareholders while fulfilling the capex requirements necessary to solve the world’s transitioning energy mix.
As at the end of March 2020, ‘Energy Transitions’ is one of eleven themes within the Fund and accounted for 6.1% of the fund total. The Global Thematic team has implemented important changes to this theme over the last few years, improving the quality of the companies held to reduce idiosyncratic risk and exposure to leverage as well as appropriately sizing the theme, which acts as a diversifier for the broader portfolio. The theme has further evolved to also holding non-energy names in recognition of the shift in the world’s energy mix.
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