The turmoil in the energy space has been fast and unprecedented.  Historically, as oil and gas investors, we have always experienced periods of price shock. This has primarily occurred during uncertainty on the supply side — fundamentally or politically. However, in the past four weeks, we have had extreme variables in both supply and demand. We will discuss these variables and how they have impacted oil and gas as an industry, oil and gas investors, and oil and gas royalties.

 

Five weeks ago the oil market had fallen below yearly low by dipping into the mid  $40 range. This represented roughly a 10 percent decline from this previous range of $50 to $65. This was due, in part, to the growth on the supply side, but also the early Coronavirus fears played a part. Then over a weekend, we learned of the price war between Saudi Arabia and Russia. With Saudi Arabia pushing more oil into an already saturated market, that Monday we experienced an extreme price collapse. With uncertainty on the supply side weighing heavily on the oil market, the inverse began to build concern on the natural gas market with the possibility of large amounts of associated gas disappearing from the market supply. With the energy space dealing with this extreme turmoil on the supply side, quickly the demand side was in question with the COVID impact on global energy use. This kind of demand destruction certainly had not been modeled by anyone. The idea of the world in quarantine for an extended period causing demand to plummet was unthinkable. Though we have been able to quantify the demand loss over the past few weeks, we still can only guess as to how demand will rebound in the coming months. We now have extreme variables to weigh on both the demand and supply side. When will the supply from Saudi and Russia slow and what supply will be lost from shut-ins? What will the demand look like in the coming months? which is highly contingent on how the virus plays out and what damage has been done to the world economies. Lack of clarity on equilibrium has never been this extreme.  

How and when will this be resolved?  It would be foolish for anyone to offer any certainty on what this new landscape will look like for the energy community. We do know it will be resolved and is being played out with continued volatility in prices, dislocation of values regionally never before seen, and capital markets dealing with the overleveraged energy sector. This will take some time, but hopefully, the energy space will emerge with a keener eye and higher efficiency in managing risk. The few groups that had their eye on the ball from a risk management perspective should be able to weather the storm.  

Most unfortunately operated with the leverage and increase production mantra — assuming price appreciation over time and ignoring extreme risks like we are now experiencing.  Here at Advanced Royalty Company, we specialize in managing these risks and helping groups properly leverage their current assets along with expansions and new purchases. We are likely in the early stages of this restructuring of oil and gas assets. There will be increasing opportunities in the coming months to use our capital and risk management to build and fortify a solid asset energy portfolio or energy production company. By having this solid base while adding strategic additional capacity, a group will be in control of their downside risk while keeping the opportunity for exceptional upside in the future.