Is energy one of the first buying opportunities to emerge from the carnage?

There will inevitably be a bit more downside to come in the energy space, but it is worth watching closely as the opportunities will not be far off, writes Nick Sudbury.

Unfortunately we already have a ‘Black Monday’ stock market crash from way back in 1987, otherwise it would have been the perfect way to remember the day when oil sent the market into freefall. The key thing to remember is that crude will also probably be one of the first areas to bottom out.

The energy market had already been hit hard by the impact of the coronavirus on expected demand, but when OPEC and Russia were unable to come to an agreement to cut production to stabilise prices, the whole situation became toxic. Saudi Arabia’s subsequent decision to increase supply, as a way to punish Russia and put pressure on the higher cost US shale producers, has knocked the bottom out of the market.

WTI crude started the year above $60 a barrel and ended last week around $40, but at time of writing had plunged to just over $30. There is every chance that it will continue towards $25 and possibly lower before the political pain forces some kind of resolution.

Oil stocks are leading the market lower

As you would expect it is the oil stocks that led the market lower on Monday with the blue chips like BP (LON:BP.)down a staggering 21% and Shell (LON:RDSB) falling 15%. The damage to the mid-caps was even more severe with Premier Oil (LON:PMO) losing more than half of its value and Tullow Oil (LON:TLW) 24%.

I strongly suspect that oil will be one of the first areas of the market to bottom and provide a buying opportunity, as it is just too damaging an area for politicians to let it go unchecked for long.

If I am right, the most lucrative returns will come from the individual oil stocks like those listed above, but it is a fraught area and you would have to do some serious research to figure out which companies have strong enough balance sheets to withstand such a major shock.

Investors who are uncomfortable with the stock-specific risk could use one of the specialist energy funds. These provide a more diversified exposure, but were already some of the worst performing vehicles even before Monday’s carnage.

For example, in the month ended Friday 6 March, Schroder ISF Global Energy, MFM Junior Oils and TB Guinness Global Energy were all down by 20% or more. The numbers will be a lot worse now.

ETCs that track the price of crude

Unless you feel comfortable picking the oil majors, I would suggest that the better alternative would be to use one of the ETCs that track the price of crude. These sidestep any stock specific issues and provide a pure albeit complex exposure to the value of the commodity itself.

Wisdom Tree have a whole range of these products linked to the two main futures contracts, WTI and Brent Crude. There is a whole spectrum of these things that have been built for different timescales ranging from a day to a month to a year, right up to two and three years.

Take the Wisdom Tree WTI Crude Oil 1yr (LON:OSW1) as an example. It is designed to enable investors to gain a total return exposure to movements in the price of one year WTI crude oil futures contracts plus a collateral yield. This is achieved via fully funded uncollateralised swaps with Shell Trading Switzerland AG, a member of the Royal Dutch Shell Group.

OSW1 has assets under management of about $0.5m and a management fee of 0.49% as well as other costs like the daily swap rate. It is complicated, but so is trying to research individual oil stocks if you do it properly.

There will inevitably be a bit more downside to come in the energy space, but it is worth watching closely as the opportunities will not be far off. Longer term there will be other challenges, most notably the move to clean energy, but for now it is the coronavirus that is the main concern. Once things have settled down we will probably find that Covid-19 has done more to slow the progress of climate change than Greta and all her activist chums put together.