ASSETCO MANAGEMENT AG
Advisors in Wealth Since 1996
Oil price crash: for now less light rather than a shadow 11.03.2020
___________________________________________________________________________________________________________________________________________
The failure of the OPEC+ negotiations with Russia regarding production cutbacks last Friday led to the sharpest oil price slump since the Gulf War in 1991, to a low of 31 USD/barrel (currently: just under 38 USD). Since the start of 2020, the oil price drop even hit 50%!
Background: Instead of an additional production cut, proposed by Saudi Arabia, now even the previous production cuts of 2.1 million barrels/day are being questioned. The oversupply on the oil market is now expanding not only based on a corona-induced drop in demand, but also because of production increases by OPEC+.
In the past, economists agreed that a low oil price is good for the global economy. This was because only a few producing countries suffered from low oil prices, while numerous (net) consumer countries benefited. This logic was already refuted with the last oil price collapse in 2015. The sharp drop in oil prices in 2015 proved rather bad for the global economy and capital markets - at least in the short term.
For one thing, the many net energy importers of today are far less dependent on oil supplies than in the past, and their purchasing power therefore does not increase that much when oil prices drop. Moreover, the US, instead of being one of the largest net oil importers, now even has a slight export energy surplus. At the same time, the US fracking industry has become an important growth driver for the US economy. The sector accounts for a good 10% of US industrial production. Importantly, the majority of oil production projects become unprofitable when oil prices fall below USD 50, which will result in company bankruptcies and layoffs. Thus, the US economy could develop stronger weaknesses in the second quarter than previously expected.
Moreover, as early as 2015, consumers did not use the additional purchasing power offered by lower oil prices to boost their private consumption and stimulate the economy. Rather, they saw the sharp drop in prices as a one-off slip (and not a permanent effect) and saved the surplus household money. At present, this is likely to become even more pronounced as many consumers are unsettled by the corona virus. Positive effects on consumption and the economy can only be expected in the medium term. This is because the emerging anti-inflationary effect of the fall in oil prices will likely further increase pressure on central banks to relax monetary policy in the short term, though this will only have an impact on the real economy in the medium term at best.
In contrast, the oil price collapse has clearly negative consequences for American high-yield bonds where fracking companies are strongly represented, in particular. Their expected default rates will have spillover effects on other risk assets. And rising risk premiums for low-rated corporate bonds are usually accompanied by declining P/E ratios on the stock market. While energy stocks are represented in the EuroStoxx by only about 5%, the energy sector in the USA accounts for more than twice as much, depending on which index. On the other hand, large American integrated oil companies are active in the US not only upstream, but also downstream (e.g. refineries). And the latter benefit from falling oil prices
Dr. oec. Susanne Toren
Chief Economist
Assetco Management