Oil Price War – Another Facet of Uncertainty

Happy Monday?

Oil prices, already beleaguered by softening demand owing to the coronavirus, opened another 30% lower to $35/barrel after disintegration of the OPEC+ alliance triggered a full blown price war among the world’s biggest oil producers.  The oil price shock adds another facet of uncertainty during a period of instability for the global economy and markets.  As a result, domestic stocks are poised to open significantly lower this morning and the U.S. ten year treasury yield plunged to a new record low of 0.33%.

What Happened?

Late last week, OPEC member countries and allies (OPEC+ collectively) convened in Vienna, Austria in hopes of agreeing to limit oil production with the goal of steadying the market against the impact of the coronavirus.  Talks, and an important alliance between Saudi Arabia and Russia, reportedly broke down after Russia balked at the proposed scale of production cuts.  Over the weekend, Saudi Arabia responded aggressively, launching an all-out price war by discounting prices and committing to boost production beginning in April.

The strategy appears to target Russia and U.S. shale oil firms, many of which are known to have high production costs and lose money when crude prices fall below $50/barrel for more than a few months. Other Middle Eastern OPEC producers such as Iraq, Kuwait, and the United Arab Emirates, are expect to follow Saudi Arabia’s lead with price cuts and increased production.

What is the impact?

The energy industry as a whole, and specifically oil prices, represent a double-edged economic sword.  On the one hand, consumers benefit from lower energy costs when lower prices at the pump and more reasonable utility bills translate to more disposable income.  On the other hand, the health of the energy industry, which represents an estimated 6%-8% of U.S. GDP and more than 10 million U.S. jobs, suffers when oil prices remain low.  There is typically a balance between these two interests, though in this case, the benefit to consumers is likely muted as efforts to contain the coronavirus are already dampening demand.

What next?

The magnitude of the decline in oil prices and the market’s response are nearly as unnerving as the continued spread of the coronavirus. It is unclear how this situation will unfold from here.  The Saudi strategy could be to force Russia and other producers back to the negotiating table, and then quickly reverse production increases if a deal is achieved.  For what it’s worth, the OPEC+ Joint Technical Committee, which includes both Saudi and Russian officials plans to meet on March 18 to review the global oil market – a sign that both sides remain in some level of talks for now.

Unfortunately, we cannot say with confidence whether the narrative improves or deteriorates in the near-term.  The unprecedented level of uncertainty present today makes it extraordinarily difficult to precisely value assets.  In the short term, today could be a buying opportunity or an advantageous exit point (assuming one knows when to get back in), but history tells us that over the long term, disciplined investors will be rewarded.

We will continue to monitor developments and communicate our views.  In the meantime, don’t lose sight of the fact that your financial plan, and the investment portfolio supporting that plan, were developed with a long-term lens and maintaining discipline during periods of uncertainty is the most reliable course for growing and preserving wealth.  Please contact any member of our team if you have questions.