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Is the oil plunge good news for responsible investors?

Timely insights on the issues that matter most to investors.

The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance fund. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results.

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      By Jennifer Sireklove, CFAManaging Director of Investment Strategy, Parametric Portfolio Associates LLC

      Seattle - Responsible investors and the fossil fuel industry have a contentious relationship. Some investors outright object to the industry's end product; other investors are concerned about the way they conduct business, from labor conditions and worker safety to human rights and ethics in their global operations.

      Either way, many ESG-aware portfolios tend to have an underweight to energy companies and have benefited from the plunge in oil prices during the first quarter. Although this is a much-needed glimmer of good news for some investors, we'd be cautious of banking on this trend for the long run.

      The price of West Texas Intermediate (WTI) crude fell a breathtaking 65% in the first quarter. Although prices have bounced back somewhat since the end of March, they're still off by about 60% from where they entered the year, making this one of oil's steepest and fastest declines in the last two decades.

      The price war between Russia and Saudi Arabia was a contributing factor; however, far more consequential was the truly unprecedented drop in demand. By some estimates, with significant portions of the global population on lockdown and the entire airline industry at a standstill, global demand has fallen by 20% in the space of a month.1 Without commensurate reductions in supply, a sharp reduction in the market-clearing price would be the natural consequence.

      However, once the COVID-19 pandemic is brought under control and economic activity normalizes, it seems likely that we'll see some rebound in oil prices. We can't know by when or how much, but prices can rise as abruptly as they can fall. What we find remarkable in our own research is how quickly the effects of oil price gyrations can dissipate in a fossil-free portfolio over the longer term, for better or for worse. Over periods of three to five years, the returns of a fossil-free portfolio and a portfolio fully invested in energy companies tend to be completely indistinguishable, with deviations in the underlying commodity price offsetting one another.

      But what if demand remains subdued and lower oil prices are here to stay? If economies adjust to prolonged lockdowns and businesses are forced to embrace remote and virtual work, some of these adjustments might stick, which could reshape long-term demand for fossil fuels. However, this could also actually work against a green energy transition to some extent. Abrupt declines in oil prices can make carbon-based energy products more competitive against renewable energy production.

      Furthermore, to the extent that oil and gas companies can play a role in investing in renewables, this might become harder if their balance sheets come under pressure. This doesn't mean that there aren't creative ways to continue to decrease humanity's reliance on fossil fuels — only that low oil prices actually do those efforts no favors.

      Bottom line: In our view, the longer-term trend toward recognition of climate change as a serious matter and the role of investors in helping to address it remains in place. However, we think investors should be aware that the recent gyrations in energy stock prices could be driven by more short-lived demand destruction. Even longer-term demand destruction might produce some anticipated bumps in the road to progress. We'll be watching these trends closely.