If we never experience the chill of a dark winter, it is very unlikely that we will ever cherish the warmth of a bright summer’s day. ~ Anthon St. Maarten, author of “Divine Living”
Question: I understand that the Coronavirus is causing consumers and businesses to use less oil and that there is also reduced demand for many goods and services. Is there another reason why the price of oil is so low?
Answer: You’re right, there are two reasons why oil prices are down so dramatically. The first is obviously Coronavirus, or COVID-19, which is causing worldwide economic activity to dramatically slow, and the second reason that’s compounding the obvious problem is a price-war between Russia and Saudi Arabia.
As with other materials, the price of oil is influenced by the relationship between supply and demand. In addition, oil prices are also closely tied to geopolitical forces. Russia and Saudi Arabia are presumably using their oil pricing-power to keep prices low. This, along with already having a reduced demand situation resulting from COVID-19, means that the price will likely remain low. As of March 24th, as this is being written, the price of a barrel of WTI West Texas Cruel Oil is currently $23.81 a barrel.
In more normal times, lower oil prices would ostensibly be a positive thing and benefit consumers filling their gas tanks while helping the bottom line of companies dependent upon the transportation industry. At the moment, the uncertainties surrounding COVID-19 are decreasing oil demand as we curtail our activity, economic and otherwise, with various restrictions.
An improvement in demand would require more certainty about the timeline for COVID-19 and depend on the easing of these restrictions. This will largely be a function of medical and public health developments related to the virus. No one is certain of how long it will take for hard-hit industries like travel, tourism, hospitality, retail, and restaurants, or almost anything discretionary to come back and produce stable cash-flow, balance sheets and employment levels.
To some extent, price-war over oil is based on another important, yet often overlooked issue between Russia and Saudi Arabia. On April 22nd, 2020—which coincidentally is Lenin’s 150th birthday—there will be a constitutional referendum to be held in Russia. Assuming that President Vladimir Putin wins the referendum, it’s possible that the Kremlin’s current nationalistic enthusiasm could subside. This might help open the door for negotiations and perhaps even a deal with Saudi Arabia. Right now, the Saudis are flooding the global market in a battle to hurt Russia’s economy with low prices. These low prices threaten to impact all countries and corporations who rely on income from oil and gas production. The economic impact is likely to be felt by producers and consumers in terms of income.
It’s common sense that during times of greater economic certainty, oil producers and distributors would prefer a higher price for their product while consumers, when they start consuming again, characteristically benefit from lower oil prices. As we know, these are extraordinary times due to COVID-19 causing demand to be low while supply is high along with the geopolitical price-wars.
Ordinarily, low prices could lead to demand increasing which tends to take care of the oversupply issue, but that’s not the case at the moment. We’re not certain how long this economic slowdown may last. Saudi Arabia is discounting prices to maintain market share and punish other oil-producing countries like Russia and the United States. This behavior is a form of international arm-wrestling seeing which economy can withstand low prices the longest.
On a more optimistic note, this is an opportunity for the United States to fill our strategic petroleum reserve tanks. Finally, it is worth mentioning that according to the Raymond James Energy Analyst, Pavel Molchanov, the Saudi economy needs $70 per barrel Brent to balance its fiscal requirements, so this can’t be good news for them. We’ll be watching to see who blinks first—Russia or the Saudi’s—in this high-priced game of chicken. As we navigate this unusual period of time, we don’t know how long oil will stay at these lower prices. Stay focused and plan accordingly.
This material is being provided for informational purposes only and has been obtained from sources considered reliable, but we do not guarantee that the material presented is accurate or that it provides a complete description of the securities, markets or developments mentioned. Any information should not be deemed a recommendation to buy, hold, or sell any security. There is no assurance any of the trends mentioned will continue or that any of the forecasts mentioned will occur. Economic and market conditions are subject to change. Investing involves risk including the possible loss of capital. Past performance may not be indicative of future results. The opinions expressed are those of the writer as of March 24th, 2020, but not necessarily those of Raymond James and Associates, and are subject to change at any time based on market conditions and other factors. “Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.” This article provided by Darcie Guerin, CFP®, Vice President, Investments & Branch Manager of Raymond James & Associates, Inc. Member New York Stock Exchange/SIPC 606 Bald Eagle Dr. Suite 401, Marco Island, FL 34145. She may be reached at 239-389-1041, email firstname.lastname@example.org. Website: www.raymondjames.com/Darcie.