As fears surrounding the spread of coronavirus (COVID-19) and what it could mean to the global economy reached new highs, financial markets across the world have been in decline. Adding to the stress of an already fragile global economy on March 6, OPEC+ talks of reducing the supply of oil between the second-and-third largest producers in the world — Russia and Saudi Arabia — collapsed. Russia refused to cut its production and Saudi Arabia announced its plans to increase production by as much as 3 million additional barrels per day beginning in April.
When oil trading resumed on March 8, the price per barrel immediately dropped 30 percent, the largest one-day decline since the Persian Gulf War in 1991. By the time the dust had settled, the West Texas Intermediate (WTI) benchmark for U.S. crude oil had bounced back nearly 8 percent into the low $30s.
While cooler heads and common sense may prevail over time, it appears, at least in the short term, that assaults on both demand from COVID-19, the global economic slowdown and the battle over oil production among OPEC+ members will ensure the world will be awash in large quantities of cheap crude oil. For the time being, $30 oil — whether it is fueled by a more short-term technical trading or is founded on a change in long-term fundamentals — should have direct oil and natural gas investors captivated by the prospect of new ways to capitalize on the sudden drop in price.
FROM CRISIS COMES OPPORTUNITY
While lower oil prices might be viewed as a threat to many in the energy sector, as a company that has not only survived but thrived in multiple energy and market pricing cycles over the past 40 years, we have witnessed first-hand how sudden changes in oil pricing create some of the best opportunities for direct energy investors.
For anyone who closely follows the oil and gas sector, you already know that high leverage ratios and debt burdens have been a significant threat to oil and gas companies in recent years. If oil prices remain low, capitulation of energy assets from potentially hundreds of distressed sellers with either weak balance sheets or who lack access to financing is inevitable.
Energy companies and funds that offer low levels of debt, the technical expertise to operate assets, access to capital, and solid financial positions will be in a significantly stronger position for growth if less-than-stellar oil prices remain.
EXPECT MORE ACQUISITION-STYLE OPPORTUNITIES
Over the past several years there has been a steady transition from Drilling Fund structures that are known for potentially high upfront tax advantages to Acquisition-Focused structures. While demand for Drilling Funds remain strong, and maybe even a little inflated in recent years as high-net-worth investors continue to have a need to replace other tax deductions lost from the 2017 Tax Cuts and Jobs Act, acquisition-style projects continue to become more mainstream. In addition to providing a larger segment of investors with ownership in a wide range of energy assets providing income and tax diversification, acquisition projects likely provide investors with some of the most attractive opportunities to capitalize on low pricing.
Should $30 oil persist, 2020 could provide direct energy investors with some of the greatest opportunities to acquire assets.
Adding to the already attractive asset valuations and the expectation of seeing per-barrel oil prices of $30, it is also worth pointing out that several sought-after regions for oil and gas operations — including the Permian Basin in the southeastern United States, and Eagle Ford Shale in Texas — are located in regions that have been designed by the U.S. Department of the Treasury as qualified opportunity zones. Opportunity zones allow individuals and corporations to invest in qualified areas to receive significant tax benefits if they realize short- or long-term capital gains, an added benefit for some investors.
While oil prices this year may be bumpy, direct investors should be excited about the potential that $30 oil creates to capitalize on the current energy market and build a tax-advantaged portfolio. Investors should be actively searching out opportunities to partner with companies that have shown an ability to create arbitrages and other opportunities from crisis.
Matthew Iak is executive vice president and director at U.S. Energy Development Corp.