As the COVID-19 pandemic continues on its rampage worldwide, a clear loser has been oil. For the first time in history, US oil futures for May closed in negative territory, thus implying that sellers were willing to pay buyers for taking their stock.
How did we get here?
Oil is an essential commodity to an economy and is used in a variety of sectors. Prior to this outbreak, global demand for crude oil was on an upward trajectory, where demand in 2019 stood at 100.1 million barrels per day (“bpd”), an increase of 16 per cent over the past decade (2010: 86.4 million bpd).
The global spread of the coronavirus resulted in the suspension of several industries some of which are heavy oil consumers, such as the manufacturing, sea and air transport industries. Consequently, the demand for oil plunged downwards, with the International Energy Agency warning that the market will face the lowest oil demand in 25 years.
To complicate this further, geopolitical tensions between oil producers resulted in oil production cuts failing to offset the deepest fall ever in demand, with Russia and Saudi Arabia flooding the world with excess supply.
This double black swan has presented us with a new reality, where the world is running out of oil storage capacity. The oil industry was aware of this problem, but the unprecedented trading in the May futures contract for West Texas Intermediate (WTI) crude, where it closed at a negative $37.63 on Monday, highlighted how real the problem is.
It is worthy to note that this plunge, being the lowest on record going back to 1983, is partly attributable to the characteristics of the futures market, where parties are obliged to deliver the underlying commodity on expiration of the futures contract. Thus, buyers of the US WTI May futures (expired on 21 April) were obliged to take delivery of the commodity with no place to store it, consequently resulted in them being willing to pay buyers in order to cancel the futures contract.
How did the oil plunge impact MedServ plc?
Last week, MedServ plc announced that due to the current COVID-19 pandemic, the sale to AMT S.A. has been aborted. The major shareholders noted that the deal was solely aborted due to the current situation, as otherwise, both parties agreed on all specifications within the deal.
They also noted that in the short term they do not expect to find a strategic partner, however they are confident that once the current situation stabilises they will be able to conclude a deal. The major shareholders reassured stockbrokers during a meeting held this week, that they will not accept or go forward with a deal to the detriment of minor shareholders. In the latest company announcement issued, MedServ noted that the termination of the takeover agreement with AMT is likely to impact the speed at which it can expand, reflecting the loss of anticipated synergies between the two companies.
Despite this, management reassured that they have learnt from past crises and acted promptly on all operational projects of the Group. Such measures mainly include the implementation of all possible costs cutting measures, thus ensuring that none of their projects are burning money. Naturally, this outbreak will impact the performance of the Group in 2020, however management expects EBITDA of 2021 to recover to the strong performance registered in 2019.
Notwithstanding this, management confirmed that no clients or contracts have been lost to date, with exploration projects being postponed. Management is confident that with the current projects in place, MedServ will be able to meet all of its financial obligations.
Although the oil industry is going through a rough patch, upside exists for those companies that will survive this difficult period. Oil prices should recover, as even the big players can’t afford to continue pumping out oil at such low prices. Oil is an essential commodity and once this is all over, demand will normalise and oil prices should recover.
Disclaimer: This article was issued by Rowen Bonello, research analyst at Calamatta Cuschieri. For more information visit www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.