Global impact of the oil price war-Is it likely to linger?

Oil prices recorded the steepest single day drop on 9 March 2020 since 1991 Persian Gulf War, after OPEC and Russia failed to reach a deal with the latter abandoning the suggestion of further reduction in production (taking off 1.5 million barrels a day) and Saudi Arabia announcing to offer deeply discounted oil, leaving drillers and oil service companies to feel the pain and attacking US shale producers simultaneously.

Crude Oil WTI Futures plunged by ~25% to US$31.13 a barrel on 9 March 2020 from US$41.28 a day earlier, putting risks on the fiscal health, budget and debt levels of several producers and sovereigns.

The crash in oil prices rattled markets already under the fears of coronavirus outbreak. Coronavirus has dented the demand for energy all over the world, majorly in China, the epicentre of the pandemic and the top importer of crude oil.

With the reluctance of people to travel and go to public spots, idle factories and cancelled flights, the virus has already indicated a fall in demand.

International Energy Agency has lowered its annual global demand forecast, and for the first time since 2009, a year-on-year decline of 90,000 barrels a day is expected in global demand during 2020.

Barclays slashed its oil price forecasts for 2020 due to OPEC’s inability in convincing its allies including Russia to cut production further, which in turn led Saudi Arabia to conclude that it will raise its output in April despite low demand, globally.

While falling oil prices could be perceived as an ointment during the period of economic stress, a combination of falling oil prices and fears of coronavirus are expected to increase uncertainty.

Stock Markets and corporate debt plunge

Oil accounts for over 3% of the S&P 500 Index. Banks that are the biggest lenders to the energy sector are also vulnerable to the oil sector via loans. Shares of global and US banks plunged after worries escalated that financial institutions already under the pressure of falling interest rates might be in trouble after a sharp fall in oil prices.

The equity markets tumbled after an oil price war emerged between Saudi Arabia and Russia, shaking investors’ sentiment. Stock markets have been going through roller coaster rides on the fears of global economic fallout from the virus outbreak.

Investors keep track of oil prices to have an idea about the supply and demand in the energy markets and to determine the condition of the global economy.

The fall in oil prices is not perceived good for the stock markets because it implies that the demand is falling, globally, indicating a slowdown. It also doesn’t bode well on the credit front for the leveraged companies, putting stress on corporate debt.

Impact on consumers and economies

Big importing countries like Germany, India and China are likely to benefit from decreasing energy bills.

Consumers, in general, benefit from the lower prices. A fall in oil prices and the resulting drop in gas prices serve as a cut in taxes and more money in the hands of consumers to spend. The US economy is 70% driven by consumers, where retail markets respond more directly to supply and demand. It serves as positive news for consumers in the US. In Europe, due to a higher share of taxes and surcharges in the pump prices, the benefit to consumers is lesser.

However, the fall in gas prices is expected to be outweighed by the surging fears of economic fallouts due to coronavirus and can put a stop to consumer confidence.

Entertainment and travel sectors are most likely to be affected, globally, as isolation is recommended by all the governments out of the fears of the spread of the coronavirus.

For the emerging market economies, fall in oil prices and coronavirus fears spell less growth, with trade, liquidity and capital flows in negative, as per market experts.

Currencies tumble

Currency markets were in a panic, as orders from traders mushroomed after the markets opened with headlines of crisis. Currencies of major oil-exporting countries like Russia and Mexico are particularly vulnerable in such an environment.

The fall in oil prices can result in negative effects on domestic economic prospects for the countries. A risk-averse environment is crowding the markets, globally, resulting in currency volatility. The Australian and New Zealand dollar fell before bouncing back while the Canadian dollar fell against the greenback.

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However, Indian rupee declined the least among the emerging market peers, as India is an oil importer.

As the risk appetite of the investors declined and the stock markets tumbled after oil prices crash, safe-haven currencies like yen, rouble and peso rose and sent currency prices swaying.

Countries to get harmed the most

Major oil-producing countries that are in a constant urge for the market share will lose money.

Russia that is the world’s second-largest crude oil exporter seems to be protected from lower oil prices because its annual budget is balanced with an average price of around US$40 a barrel unlike the usual rate of US$60-70 a barrel.

Gulf countries like Saudi Arabia, Kuwait and the UAE produce oil at the lowest cost of US$2-6 a barrel, but due to lavish subsidies to its citizens and high government spending, a price of roughly US$70 a price is needed to maintain their budgets.

Many of the US shale oil firms have high costs of production and lose money when crude drops below US$50 a barrel for more than a few months.

Oil reliant states like Libya, Iraq, Iran and Venezuela that have suffered from years of conflict are likely to pay the heaviest price.

Coronavirus can add to the uncertainty of the global oil industry

Job cuts and lack of investment by energy producers can have a significant impact on businesses in the energy supply chain. Low oil prices can hurt energy suppliers, but many people can benefit from the lower prices also.

As coronavirus has dented the hopes of consumers to spend, any benefit of lower oil prices that flows to consumers is unlikely to result in a boost in spending by consumers.

With oil demand already plunging due to the economic impact of coronavirus, traders predict a further drop in oil prices. The likelihood of another price war is alarming traders already.

If the rise in new infections due to coronavirus slows down in other parts of the world like China and all the unease in markets result in just a short-term fall in the confidence of consumers, there is a possibility of improved economic and political environment, globally.

However, it is expected that the suppliers heavily reliant on oil & gas revenue will face constant challenges.

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