Oil prices fell to a four-year low today after Russia and Saudi Arabia began a price war that triggered major stock market sell-offs.
The two oil-producing titans were in talks over a further production cut to protect oil prices against the coronavirus outbreak. But Russia blanched at the prospect of slashing another 1.5m barrels per day.
Saudi Arabia responded by flooding the market with oil in a bid to collapse oil prices in a dramatic end to oil cartel Opec’s alliance with Russia.
That sent oil prices crashing 30 per cent today, their largest one-day fall since the Gulf War.
European stocks and US stocks both recorded huge plunges as a result.
It came as the International Energy Agency (IEA) warned global oil demand will contract this year due to coronavirus, the first time this would have happened since 2009.
However, the IEA also predicted demand will rebound in 2021.
Brent crude opened in London at $31 a barrel this morning, the lowest level since February 2016.
It later recovered to $36 but this marked the largest fall in a single day since the 1991 Gulf War.
As a result, shares in major international oil producers have fallen in addition to the FTSE 100.
IEA executive director Fatih Birol warned against overreaction.
“At such a time of uncertainty and potential vulnerability to the world economy… playing Russian roulette with the oil markets may well have grave consequences,” he said.
‘Oil set to revisit 2016 levels’
Artur Baluszynski, head of research at investor Henderson Rowe, said: “With Russia walking out on Opec, oil prices are very likely to visit the 2016 lows.
“Russia is willing to sacrifice its short-term economic wellbeing for longer term geopolitical goals of weakening Saudi Arabia and debt-addicted US shale producers.
“Oil and mining heavy indices such as FTSE 100, already weakened by the coronavirus, are massively exposed.”
AJ Bell investment director Russ Mould called the stock sell-off a “panicky overreaction”.
“If anything a weak oil price is good news for more countries and industries than it is bad,” Mould added.
“History shows that a 50 per cent year-on-year increase in the oil price has tended to lead to a slowdown in global GDP growth and a 100 per cent year-on-year increase has nearly always ushered in a recession, because of the hit to consumer spending power and companies’ cost base.
“The opposite also holds true. Oil is now down by some 46 per cent year-on-year, with Brent at $35.42 a barrel, and since 1970 there have been three instances when oil has fallen by 50 per cent year-on-year or more. On each occasion (1986, 2008-09, 2015-16) global GDP growth rates improved. Sharp drops in oil that did not quite reach the 50 per cent mark in 1989, 1992, 1998 and 2001-02 also did no harm to economic momentum and if anything helped it, this time thanks to the benefit to consumers’ spending power and reduction in many companies’ input costs.”
Cracks are appearing in Opec+
Traditionally a major player in the global oil market, divisions are now emerging in Opec, according to Randeep Somel, equities investment director at M&G Investments.
“The jitters in global demand created by Covid-19 (coronavirus) have exposed the fragilities in one of the world’s largest intergovernmental groups,” he said.
“The relationship has become frayed over the last five to six years as oil demand has been volatile alongside the global economy.”
Adding to the issues has been a new supply of oil brought onto the market through the advent of hydraulic fracturing, he said.
“This has led to the US becoming the world’s largest oil producer, and taken away further OPEC’s ability to maintain price through its control over supply.”
US shale exposed to oil prices cut
“Russia has taken harsh measures on its domestic budget, this means it is now in a position where it can afford a lower oil price,” Somel added.
“The US shale producers, which are higher cost, have been helped by cheap debt to continually fund their production.
“This collapse in oil prices will hurt their ability to access debt.”
“The shale producers typically hedge production six months to one year forward, so the supply cuts will not be immediate if the oil price stays at this level.”
Oil prices cut could lower energy bills
Despite the international economic volatility, consumers may be in line to benefit from the cut in oil prices.
“The oil price crash could be good new for consumers, who may see a knock-on effect of reduced houshold gas and electricity prices if this situation continues, said Will Owen, energy expert at Uswitch.com.
“But any impact will take time to work its way through to bills, especially for consumers who are on fixed-rate deals.
“People will start to use less energy anyway as we head towards warmer temperatures and light evenings through the spring, so households may not notice any major differences until next winter.
“Even then, the oil price drop will only work its way though the systems if it’s prolonged and starts to depress the wholesale prices which energy suppliers pay for gas and electricity on the open market.”
It could get worse for oil giants
Although these price falls are near record levels, things may get worse before they get better.
Callum Macpherson, Investec’s head of commodities, outlined two events that, if they happen, could make matters worse for energy stocks.
“One: General Haftar succeeds in taking Tripoli, bringing the civil war in Libya to an end – his next step would likely be to restore oil production, bringing another 1m barrels per day back into the market that nobody needs,” he said.
“Two: Coronavirus disrupts the US driving season. If the virus does not dissipate over the summer, and the US driving season is disrupted, the consequences for demand could be very serious indeed.”
Oil prices set to languish below $40
Cailin Birch, global economist at the Economist Intelligence Unit, said: “We expect oil prices to remain at or below $40 in the coming days.
“There is now significant weakness on the supply outlook, in addition to the demand outlook. The breakdown of Saudi-Russia talks at the latest Opec+ meeting on has sent these two producers into a renewed price war.
“Both Saudi and Russia will ramp up production in the coming months, in an effort to regain market share from the US shale sector. “
She added: “The real impact on oil markets, beyond today’s knee-jerk reaction, will depend on how quickly Saudi and Russia ramp up production. If oil prices remain closer to $30 in the coming weeks, this could encourage some restraint in both countries which rely heavily on oil to balance their budgets and maintain economic stability.”