It’s safe to say the financial markets are in panic mode.
This week has seen a wild start, with oil prices collapsing the most since the Gulf War and stock prices plunging to limit downs. Global events are creating a historic period in the markets and it’s not just the coronavirus creating disruption. We also have issues with oil.
So, what on Earth is going on?
Of course, we have to start by mentioning — you guessed it — coronavirus. As it continues to spread outside China and numbers continue to escalate, fears about the impact to global economic growth have increased. In particular, the current and expected demand for oil this year has taken a big hit, leading to price declines over the past weeks.
In general, if demand for oil is dropping, you’d expect production to reduce to limit the amount of supply and, therefore, stabilise prices. However, this is part of the reason why oil prices collapsed so much at the start of this week. Supply is not going to be adjusting to the drop in demand.
Let’s rewind to 6 March — last Friday.
There was an OPEC+ meeting taking place which was very important. Unfortunately, head honchos Saudi Arabia and Russia were not seeing eye to eye.
Saudi Arabia and OPEC were looking for a deal to limit production, which would cut supply and create a floor for the price. However, Russia wasn’t on board with this and declined the deal. They were going to allow producers to keep on pumping.
For Russia, this may be seen as their chance to take advantage of the high cost of US shale production and squeeze those producers out of the market. It seems this was an opportunity they were not willing to miss after years of US shale companies saturating the market and sanctions on Russian oil.
Saudi Arabia wasn’t on board, but then over the weekend they unexpectedly decided to slash prices and increase production anyway. This has created a price war and a race to the bottom for oil producers.
What will happen next is uncertain, but if oil remains at extremely low prices it would put oil-producing countries at risk, such as Iran and Venezuela, and certain US states such as Texas. Some analysts, such as those at Goldman Sachs, think prices could reach the $20 region very quickly and some have even stated extreme prices below $10 per barrel.
Unlike the situation when oil collapsed in 2015, Russia will be able to weather the storm better due to cuts in fiscal spending and the build-up in recent years of a $170bn national wealth reserve, which it can tap into if the price war continues for a long time.
Russia also has a floating currency which gives it an advantage over Saudi Arabia when it comes to being able to maintain low prices. This could also be the end of Russian and OPEC cooperation even once the world has recovered from the effects of the virus.
The US, on the other hand, is in a different situation. Previously they were an importer of oil which meant low oil prices would have been beneficial, but since they are now a net exporter, low oil prices could offset any stimulus low prices offer.
However on a global scale, at this extremely uncertain time, perhaps low oil prices will help with any recovery from the impact on global growth that has and is being caused by the virus. What do you think?