Oil price sell off
On March 9, Oil prices fell by more than 30% – the largest one-day decline since the 1991 Gulf War.1 Here, Newton’s Real Return team and Shamik Dhar, chief economist, BNY Mellon Investment Management, offer their thoughts on the sell-off and what it means for the wider market.
Shamik Dhar, chief economist, BNY Mellon Investment Management:
The oil price collapse is yet another shock for fragile economies and markets to cope with – all against the background of turmoil in financial markets generally. Demand for oil had been weak anyway – thanks to the impact of coronavirus, so Saudi Arabia’s decision to turn on the taps layers a supply shock on top of that. The fundamental driver is geopolitical: this is about retaining control of the oil market in the longer run. Saudi Arabia has been prepared to drive prices down in the past to contain or eliminate competitors or those unwilling to toe the OPEC line – with varying degrees of success. Its target is Russia this time, just as it was US shale companies in 2014/15, Venezuela in the late 1990s and Texas in the mid-1980s. It’s hard to say how long this will last, but it doesn’t look like a short-lived development at the moment.
Of course, the oil price fall will help support growth in oil-importing countries, which will enjoy a terms of trade gain. There is a transfer of income from oil producers to oil consumers, and that could boost global growth if the consumers spend more from their income gains than producers cut spending. Every US$10 fall in oil prices transfers around 0.3% of world GDP from producers to consumers.
The boost is unlikely to be large enough to stabilize a world economy faltering from the impact of Covid-19, but low oil prices could prove a favourable environment once the impact of the virus has passed later this year. The oil price fall also boosts market uncertainty – and obviously today’s events demonstrate there’s a lot of fear about already. A sharp slowdown in world growth this year looks likely, possibly even global recession in the first half. One ‘bright spot’ is that global carbon emissions could well fall this year, though again, at the margin, the oil price fall will moderate that reduction a bit.
Newton’s Real Return team on today’s oil price crash and the impact on markets:
Ahead of the coronavirus outbreak the macroeconomic environment was showing some signs of recovery with an improvement in the global liquidity picture and in some of the leading indicators. However, panic has increasingly gripped markets as the number of cases outside China has risen. In our view this has pushed out the prospects of a recovery to the second half of the year, assuming the virus does not assume pandemic proportions.
On top of the coronavirus, we now have the oil price war to contend with and, while its direct impact is limited – oil and gas extraction including shale only contributes 1% to US GDP – the key risk is contagion to other areas of the market such as credit, which could see a widening of spreads, having already been challenged over the past few weeks.
Taking all of this together, the outcomes feel quite binary: we could either see a market collapse with a rise in credit defaults and associated market dislocations or the authorities are able to successfully intervene and an improvement in the weather could lead to a retreat of the virus. Moreover, there is a chance a combination of interest rate cuts and any fiscal easing will walk us back into a goldilocks environment once the coronavirus slowdown peaks decisively and the global economy can get back to business. However, visibility is currently limited and it is too early to say what way this will tilt.
1 This article was produced on March 9 and views expressed are as of that date.
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