In its battle over policy with Russia, Saudi Arabia has instigated an oil price war that will have major negative effects on equities, furthering the route we’ve already seen from the coronavirus correction.
Evidence of that can be seen in the current state of U.S. stock markets as of Monday morning.
All three major indexes were down nearly 7% following the announcement that Saudi Arabia hopes to push oil prices down rapidly.
The reason for the price drop? Russia.
On Friday, OPEC nations failed to agree on any policy that would stem the tide of falling prices. A major catalyst in those negotiations was Russia. Russian officials said they would not support any move to slow down production. This stance clashes with Saudi Arabia’s position to trim back production until coronavirus fears subside.
As a result, Saudi Arabia has slashed its crude oil prices and plans to increase output by almost 1 million barrels a day in the coming weeks. This is aimed to get Russia back to the table to discuss a production cut.
Impacts on the Markets
While there is no direct correlation between the price of oil and markets, Saudi Arabia’s move could not have come at a worse time.
Investors are already in sell-off mode thanks to the spread of the coronavirus, which could soon be classified a global pandemic.
That in and of itself had already triggered a roller coaster ride for U.S. markets.
In the last week, the S&P 500 swung up or down more than 2.5% for four consecutive trading days, and it was mostly down.
All three markets entered correction territory — dropping 10% from their most recent 52-week high — in recent weeks.
Additionally, the benchmark 10-year Treasury yield fell to 0.44%, indicating a continued rush by investors on safe havens.
All of it is “signaling an imminent recession,” according to CNBC’s Jim Cramer.
The collapse in yields and oil is signalling an imminent recession…I think we need to parse everything and remember that while most stocks aren't buyable, they will get to be that soon enough at this pace..
— Jim Cramer (@jimcramer) March 9, 2020
What Happens With Oil Prices?
This latest move by Saudi Arabia is aimed to bring Russia back to the table to negotiate production cuts.
The biggest question is: Will it?
Most likely, the answer is that it won’t anytime soon. It comes down to the financial position of each country. Saudi Arabia is tied closely to the U.S. dollar, but Saudi Arabia is much more flush with foreign currency reserves.
“It can sustain one or two years of a strategy like that. Others cannot. I think Russia will not sustain this for much longer and I think Russia will come back to OPEC+ as it did previously a few years ago,” ADS Investment Solutions senior executive officer Ryan Lemand told CNBC.
However, that could be a matter of months, rather than days.
On Monday morning, Brent crude futures dropped 21% to $34.76 a barrel, while West Texas Intermediate fell 21% to $32.52. It was the lowest percentage drop for West Texas Intermediate since 1991.
So the only way for oil prices to recover quickly from this impromptu price war rest on the ability for nations to contain the coronavirus outbreak.
Doing that would prop up demand for oil and push prices back to higher ground. However, as the virus continues to spread globally, the prospects for halting the outbreak seem slim.
The Heat is On Big Oil Companies
The pressure is now on large oil companies like Exxon Mobil Corp. (NYSE: XOM), BP PLC (NYSE: BP) and Chevron Corp. (NYSE: CVX).
Share prices for each of those companies were down more than 16% early Monday morning.
As long as the oil price war goes on, these companies will follow the last oil market crash of 2014. That means cutting costs, selling assets and streamlining operations to stay profitable at lower oil prices.
But all of that may not be enough for companies to maintain strong profits and dividend payouts to shareholders.
It’s likely the share prices of these companies will face even more pressure as long as the oil price war continues.
“Highly leveraged companies will be most impacted by the decline in crude prices,” Bernstein analyst Neil Beveridge said to The Financial Times.