Oil prices just turned negative: What should investors do now?

The Covid-19 pandemic has led to unprecedented measures being imposed.

With travel grounding to a near-halt, the demand for oil has also plummeted.

The resultant glut in oil supplies has caused the oil price to crash to a 21-year low of around US$20.40 (S$30) per barrel.

Yesterday, the futures contract for May had crashed from US$17.85 per barrel to close at negative US$37.63.

What this means is that traders are paying close to US$40 per barrel just for someone to take the oil off their hands.

How should investors react to this startling development? Is there any need to take action for your investment portfolio?

So, what's the big deal?

The sharp plunge in the oil price is a function of supply and demand.

With demand falling precipitously while supply continues to flow, it's only natural that the price of oil would plunge.

But, what's even more surprising is how the West Texas Intermediate (WTI) May futures have reacted.

Investors should note that futures contracts are a method used by traders for buying and selling oil to be delivered a month later.

The situation is caused by a lack of storage facilities worldwide. Assuming traders take delivery of the commodity, they will end up having to foot the exorbitant storage costs themselves.

The Singapore oil majors

Aside from this extreme example, the contract for June is still trading around US$21 per barrel.

The two blue-chip rig builders in Singapore, Keppel Corporation Limited (SGX: BN4) and Sembcorp Marine Ltd (SGX: S51) tend to be sensitive to the price of oil.

Keppel Corporation's offshore and marine order book stood at S$4.4 billion as at end-2019. The division recorded S$2.2 billion in revenue for the year but made a profit of just S$10 million.

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Fortunately, the group has its other arms to mitigate the plunge in oil price. The Property division is the main profit generator for the group, with the Infrastructure division coming in second.

Keppel's oil and gas division made up 29.3 per cent of group revenue, but took up just 1.4 per cent of the group's net profit.

In contrast, Sembcorp Marine's main revenue generator comes from the building of oil rigs and offshore platforms for the oil and gas industry.

Last year, the group reported revenue of S$2.9 billion for its rigs and floaters division. However, the division made a net loss of S$122 million.

The plunge in oil price, therefore, will impact Sembcorp Marine much more significantly than Keppel Corporation.

Implications for other businesses

The fall in oil prices isn't all bad.

Businesses in the transportation industry stand to benefit greatly from reduced fuel costs, as fuel costs form a large proportion of their expenses.

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Two examples that come to mind are Comfortdelgro Corporation Ltd (SGX: C52) and its subsidiary SBS Transit Ltd (SGX: S61).

Comfortdelgro owns a large fleet of taxis that are mostly standing idle now due to the Singapore government's "circuit breaker" measures in response to the pandemic.

The group is already waiving taxi rentals for its drivers during the circuit breaker period. The fall in fuel prices would certainly help the division to reduce its losses for this year.

The fall in fuel prices would certainly benefit SBS Transit, as the group operates a fleet of public buses as well as the North-East and Downtown MRT lines.

Singapore Airlines Limited (SGX: C6L) will no doubt benefit the most. Fuel costs took up close to 28 per cent of the group's revenue in the first nine months of the fiscal year 2020.

Unfortunately, only 4 per cent of flights are operational at the moment.

Get Smart: Lower fuel prices is a good thing

Overall, lower fuel prices benefit many individuals and businesses.

For the average family owning a car, paying less for petrol means having higher levels of disposable income that can be spent on other necessities.

Investors should, therefore, view this as a positive development.

The current over-supply of oil is solely due to the pandemic.

Once the pandemic has been contained and growth starts to resume, the demand-supply equation will shift towards higher demand, thereby lifting oil prices.

Until then, enjoy these low prices while they last.

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This article was first published in The Smart Investor. All content is displayed for general information purposes only and does not constitute professional financial advice. Disclaimer: Royston Yang does not own shares in any of the companies mentioned.