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Epic Oil Crash Sets Up Brutal Downturn for Energy Sector

But recovery is inevitable, and stocks look very cheap--just watch out for bankruptcy risk.

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Editor’s note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.

On April 20, U.S. oil prices dipped into negative territory and Brent crude swooned shortly after. The coronavirus has wreaked havoc on worldwide consumption of gasoline and other crude products, and the supply response thus far has been lethargic and ineffective. As a result, storage utilization is dangerously high, and investors who paid heavily to escape short-term crude futures may yet breathe a sigh of relief. Even before the latest oil collapse, the outlook was bleak: The 9 million barrel/day decrease in global demand that we now forecast due to COVID-19 eclipses prior downturns, and brinksmanship by Russia and Saudi Arabia has delayed a crucial response on the supply side. But extrapolating Armageddon oil prices to infinity is a mistake. We think the GDP impact of COVID-19 will be modest in the long run. Once a vaccine is developed, we see little reason for demand for most oil-related items (even for air travel) not to fully return to normal. If the intensity of consumption is not severely affected, we will eventually see strong catch-up demand, which cannot be satisfied without a contribution from U.S. shale--and that business model simply does not work at strip prices. The marginal cost for shale producers is $55/barrel (West Texas Intermediate), and without a recovery to that level, shale investment will fall far short of what’s necessary.

Preston Caldwell does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.