As the coronavirus scare rolls on, there is no shortage of sober, responsible voices telling us that panic over the virus can do more damage than the virus itself.
That’s true as far as it goes, but it only goes so far. Much of the market panic isn’t about the virus but about the responses to it. At this writing, the entire country of Italy has quarantined itself. A substantial chunk of Chinese economic activity has halted temporarily, enough to be reflected in satellite images showing dramatically cleaner skies over parts of the country as oil- and coal-burning activity ceases or is greatly reduced. Since China is now the world’s manufacturing floor, that halt in activity is inevitably reflected in reduced demand for oil. Daniel Yergin of IHS market estimates the drop in world demand at 3.8 million barrels in the first quarter of 2020, the biggest ever and larger than the drop during the financial crisis of 2008.
On top of a reduction in demand for oil due to reduced economic activity because of virus fears—Chinese factories closing, more people staying home, fewer cruises, restricted travel—Saudi Arabia has chosen this moment to start an oil price war with Russia. (One business publication called it a “black swan on top of a black swan.”)
According to news reports, Saudi Arabia’s leader, Mohammed bin Salman, wanted Russia to join OPEC in production cuts. Russia refused; it sees low prices as slowing the rise of U.S. shale gas and oil, its prime competitor now. Saudi Arabia retaliated by opening its oil spigots. Saudi Arabia also wanted to hurt regional rival and fellow oil-producer Iran, already struggling from U.S. sanctions, increasing internal dissent and from being one of the countries hardest hit by the coronavirus.
The price drop will hurt Saudi Arabia itself in the short term, as well as its closest ally, the U.S. The U.S. benchmark price of oil dropped 25 percent to $31.13 a barrel on March 9, the biggest single day drop since 1991; the drop brought oil prices to half of what they were as recently as January. Few U.S. producers are thought to be able to turn a profit at prices around $30 a barrel.
For decades, Americans were used to cheering at news of oil price drops. Managing oil price hikes was a major goal of U.S. foreign policy. But now that the U.S. is a major oil producer again, thanks to fracking, the dramatic oil price drops threaten a big chunk of the U.S. economy. Many U.S. drillers are already operating at the margins of bankruptcy. Scott Sheffield, CEO of Pioneer Natural Resources Company, told the Wall Street Journal that if low prices continue, 50 percent of public E&Ps [exploration and production oil drillers] could go bankrupt over the next two years.
The glut plus reduced demand could slow and even temporarily freeze oil supply chains; there are reports of tankers full of oil riding at anchor, being used as oceangoing warehouses while traders look for a sliver of price daylight. Since oil powers the world economy, its movements are closely tracked by the stock market, although that correlation has been complicated by coronavirus reactions. All this will no doubt affect barged movements of oil in the near term.