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Now an oil shock hits markets

Energy consumers may be winners, but the slumping oil price could do a lot of economic damage.

Oil platform in the middle of the sea

by
John Redwood

in Features

09.03.2020

The viral epidemic has been dominating investors’ minds, as analysts wrestle with how long the virus may continue to spread and work out how much growth will be lost and revenues cut for leading companies. Late last week the fall in demand and confidence generally was compounded by an unexpected row between Russia and Saudi Arabia over oil.

These two large oil producers had been working more closely together. Both had agreed production cuts in their oil output to keep the price above $50 barrel. Both recognised the threat to their exports from rising US shale production and from falling demand thanks to the virus. Saudi sought Russian agreement to increasing and extending the production cuts to ensure a stable oil price, despite the fall in demand. Russia decided it no longer wished to assist, and would instead allow the price to tumble and go for higher market share.

Friends un-united

Russia may be cooling on her alliance with Saudi Arabia for a number of reasons. Russia’s strong allies in the Middle East, Syria and Iran, are Saudi’s enemies. The rapprochement with Saudi maybe did not bring the inward investments Russia was hoping for. The OPEC-plus cuts gave the US a free ride to expand her output without too much price damage. These and other considerations led Russia to dig in and trigger a price war. Saudi responded strongly, offering its oil in substantial quantities at much lower prices.

Russia’s frustration with the US, in part, revolves around oil. At the end of last year President Trump imposed sanctions on the Nord Stream 2 pipeline project to try to prevent the completion of the last section of this link in Danish waters. Nord Stream 2 would allow a big increase in Russian gas exports into the EU. The US President thinks this greatly weakens the position of European allies by making them too dependent on Russian supply, whilst also meaning they will buy less US gas product. Russia says it has the technology and capability to finish the pipeline, but it seems completion has been delayed with the withdrawal of the main pipe-laying Swiss vessel under the pressure of the sanctions. Russia is also angry about the US sanctions placed on Rosneft for assisting Venezuela in selling its crude oil.

Companies hit by price war

It is always possible Russia and Saudi will pick up the phone and try to reach some compromise but, so far, both sides seem resolved to enter a price war. All the time it lasts we should expect a further hit to world output. There will be cancelled investment programmes by oil companies, loss of business by oil service companies, and severe pressures on cashflows for high-cost oil producers. We should expect dividend cuts, capital reorganisations and even bankruptcies amongst the weaker players. There will be knock-on effects on the higher risk corporate bond markets, and difficult decisions for banks financing the energy industry.

This black cloud does have a silver lining for all the users of oil and gas. It will be cheaper, reducing inflationary pressures more. It means companies and individuals whose income is holding up have more to spend on things other than energy. It will see some transfer of income from oil-producing economies to oil-consuming ones.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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