June 19, 2020 | Author: Kristina Hooper, (Chief Global Market Strategist)
E-commerce takes greater hold among food shoppers, while energy demand starts to recover
Across the US, states are easing their lockdowns, and people are going back to the gym, eating out at restaurants, and taking summer road trips. At the same time, habits that were adopted or accelerated during lockdown — like online shopping — could represent a lasting shift as consumers grow accustomed to the convenience. Below, four Invesco’s portfolio managers discuss the impact of these developments on consumer trends and on the energy industry.
Consumer trends: Grocery shoppers show increased appetite for e-commerce
Ido Cohen: We believe the coronavirus has accelerated secular trends in shopping that were already in motion. Specifically, social distancing has accelerated the shift to e-commerce, driving many consumers to increase their e-commerce utilization and adopt these tools for a broader set of product categories. The biggest impact here is the increased adoption of the very large and relatively underpenetrated food and consumables categories. Together, food and consumables represent almost one-third of all US retail spending.1 Pre-coronavirus, e-commerce represented only mid-single-digit market share of these purchases, but recent data suggests that has likely at least doubled to the low double-digits following social distancing requirements.2 We believe the main beneficiaries here are the large e-commerce platforms and meal plan or restaurant delivery specialists.
Across all categories, we have seen e-commerce platforms and specialists gain share to the detriment of brick and mortar retail businesses. While the shift to e-commerce may be experiencing an unusual boost during this period, we believe some level of accelerated adoption may be maintained for the foreseeable future – driving long-term behavioral shifts that may not revert back to prior routines. This is because e-commerce was already taking share through its advantages of convenience, selection, product information/reviews and round-the clock-availability. Further, as share shifts and brick and mortar volumes fall, economic pressure will increase to have fewer stores, thus reinforcing the shift to e-commerce.
But while store-based retail has a natural digital substitute in e-commerce, and may thus feel long-term echoes from this period of social distancing, we believe many consumer-focused experiences are unique and will continue to drive physical excursions in the future. For example, we believe it is unique to eat in the ambiance of a restaurant, gamble in a casino, go to a concert or a movie theatre, experience a museum, or travel to see unique cultures and sites. While many of these experiences have been curtailed or reduced during this period of social distancing, we believe they will recover over time and likely with great momentum once a vaccine is deployed. In contrast, we are less sure about the recovery of business-related excursions and travel. Social distancing has driven a large migration to digital tools for meetings and conferences, and we believe many companies are beginning to view these tools as equally effective at greatly reduced cost versus business travel. This may lead to a long-term headwind for a full business travel recovery.
Oil producers: Supply/demand regains balance after April’s dramatic price plunge
David Hemming & Theodore Samulowitz: West Texas Intermediate (WTI) crude oil has rallied $80 in the past two months. From -$43 to $38, it has been quite the reversal since the expiry of the May futures contract.3 The July WTI contract is up 33% from its April lows,3 which were caused by the dual shock of demand destruction from the COVID-19 related global lockdowns, and surplus supply from the Organization of Petroleum Exporting Countries (OPEC), whose supply cuts were not rolled over in April after an acrimonious meeting in Vienna on March 6.
In the past six weeks the global crude market has stabilized, as fears of the supply glut maxing out global storage capacity were not realized, and the market has started to draw down that supply as lockdowns are eased and demand has come back faster than most experts expected. In our view, the biggest crack in the recovery will be working through the large product inventories (such as gasoline and diesel fuel, for example), as refiners have seen their margins narrow with the recent crude oil rally. Another concern is that prices have rallied high enough that producers are starting to bring back shut-in oil wells, which could stem the tide of oil leaving Cushing Oklahoma, the WTI pricing location.
Over the longer-term, we believe energy commodities still look attractive as oil producers would like higher prices to either clear budgetary breakeven levels nearer $50 for Brent crude oil or higher (for national oil producers) or be able to hedge production profitably around $45 WTI (for US shale producers). There was disappointment that OPEC+ only extended the agreed May cuts for one month. However, the structure of the cuts means that production should be managed for the next year as traffic congestion is expected to normalize. Contributing to the bull case is that US shale producers’ capex spending has dropped 53%,4 which means there could be periods of significant tightness in the year to come.
Midstream energy: We believe US crude basins may begin to grow as global demand normalizes
Brian Watson: Like much of the economy, the energy infrastructure, or midstream, industry has been impacted by the COVID-19 containment efforts. An unprecedented fall in demand for jet fuel, gasoline, and diesel disrupted the supply and demand balance for crude oil, made worse by a short-lived OPEC deadlock that temporarily lifted supply, which sent crude oil prices tumbling and resulted in a dramatic shift in North American production expectations.
Midstream energy companies own and operate the long-lived, physical assets needed to solve the logistical challenges that stand between the production of raw natural resources and the delivery of resources in a usable form to consumers such as refineries, utilities and chemical plants. These assets include pipelines, treating and processing plants, terminals, and storage facilities as well as certain truck, rail and shipping assets. Notably, most of these assets earn revenue on the volumes of the commodity rather than on the price of the commodity. Therefore, the expectation for lower domestic crude oil production impacted the volume outlook for some midstream companies. However, some crude oil pipelines benefit from volume commitments and, therefore, offer the midstream operator cash flow stability even in the face of volume uncertainty.
While the outlook for domestic crude oil production has improved in recent weeks with renewed OPEC+ discipline and the beginnings of a recovery in transportation fuel demand, the timing of a full recovery remains uncertain. However, much of the midstream sector is not focused on crude oil. For example, domestic natural gas demand remains relatively stable, and the outlook for natural gas-focused midstream assets may have actually improved. In recent years, surging US crude oil production also led to a flood of natural gas produced by those same wells (termed associated gas), which depressed domestic natural gas pricing and tempered natural gas-focused drilling and volumes. With domestic crude production now set to decline modestly in the near term, we believe natural gas-focused midstream assets may benefit as natural gas-focused production becomes more heavily relied upon.
Further, while refined product demand (gasoline, diesel, jet fuel) was dramatically impacted as COVID-19 containment efforts were instituted, we expect demand recovery to also allow refined product-focused midstream volumes, and therefore revenue, to recover quickly. We remain confident in the long-term outlook for domestic production volumes and believe US crude basins can stabilize and begin to grow as global demand normalizes. Therefore, we remain confident in the outlook for domestic midstream assets as a “must-run” link in the energy value chain. Our investment process focuses on long-term investing, and our risk-adjusted valuations suggest that, on average, midstream energy equities appear attractive. Further, general sector valuation metrics remain discounted relative to historical ranges, and sector yields remain competitive with other yielding-equity classes, in our view. We are hopeful that as energy markets stabilize, these attributes may potentially attract greater investor interest and aid sector valuations and performance.
1 Source: US Census Bureau, Advance Monthly Retail Trade Survey, May 15, 2020
2 Sources: US Census Bureau, Advance Monthly Retail Trade Survey, May 15, 2020, and Food-on-Demand (industry trade publication) “Mercato Packs Up Ecommerce for Independent Grocery Stores” by Tom Kaiser, June 4, 2020
3 Source: Bloomberg, L.P., as of June 16, 2020
4 Source: Energy Aspects, “Large-cap US E&Ps slash Capex but price recovery to reduce shut-ins,” May 19, 2020