On April 20, the price of oil skidded into negative territory for the first time in history, with the May futures contract on West Texas Intermediate (WTI) crude hitting a low of –US$37.63 per barrel before recovering to positive levels.

The thud resounded across the capital markets, but with varying implications. Within the energy sector itself, the oil crash won’t have the same impact on exploration and production (E&P) companies as on midstream firms, which provide processing and transportation services to upstream producers and downstream users of natural gas liquids. The former experience the direct effect of depressed oil prices, while the latter experience second-order effects. Dramatically fluctuating oil prices also create bond price dislocations that signal opportunity.

Before we assess the implications for, and potential opportunities in, the energy sector, let’s take a look at how we got here.

A Massive Disconnect Between Supply and Demand

In the first quarter, as economies shut down in response to the coronavirus pandemic, global demand for oil dropped precipitously. Under ordinary circumstances, this demand shock alone would have strained oil prices.

But to add fuel to the fire, OPEC+* simultaneously failed to extend output cuts. This allowed Saudi Arabia and Russia to ramp up oil production, with each trying to gain market share through an all-out price war. Under an enormous glut of oil, prices slid from a January high of US$63.27 to the mid-20s in one of the largest and fastest peak-to-trough declines on record.

OPEC+ members recently reached an agreement to curtail output, but the agreed-to production cuts won’t take effect until May. And in the time between the agreement and its execution, the US ran out of room to store all the oil that had been extracted.

Severe storage constraints are likely temporary. Indeed, futures contracts on WTI for June delivery—just one month further out—have remained positive throughout this period. That’s a critically important clue for bond investors: the biggest factor in the health of energy companies is the price of oil over the longer term, not today’s supply glut. Many E&P companies have hedges in place through 2020 for precisely this reason.