4 minute read
The impact of the coronavirus crisis on the oil market and dramatic pricing moves has been widely observed. But it’s a more nuanced story than an outright negative. Read on for our views.
It feels almost safe to say that the global trend in coronavirus cases and deaths has peaked. And overall, the current news flow on the virus itself remains more good than bad. The bigger macro markets haven’t been hugely interesting as of late – the Standard & Poors 500, 10-year US Treasury and US dollar index were all pretty stable by recent standards recently. That said, there has been one big story: oil.
Oil market stress
The drastic plunge in demand for crude oil and refined energy products including petrol/gas across the globe due to shutdowns is another stark reminder of the vast impact that the coronavirus crisis is having. Falling demand has seen energy prices collapse and as a result, stockpiles have risen. Disputes between the Organization of the Petroleum Exporting Countries Plus (OPEC+)over oil supply cuts along with political tensions have only heightened market concerns of an oil supply glut.
On Monday 20 April, the WTI (West Texas Intermediate) oil prices fell below zero — albeit temporarily — for the first time in history. While this was due partly to technical trading factors, there is no denying that the oil story will be a long burner. The latest addition to the global story comes from Norway who has cut oil production by 13% in an unofficial pact with OPEC+, the first time it has done so in more than a decade.
But if we look at the fundamental aspects of the oil drama, the story is more nuanced than outright negative. And in our view, the drastic moves in oil pricing don’t necessarily reflect the realistic outlook for global growth. We think it’s overstated. Here are four reasons why:
Four reasons why the oil drama doesn’t reflect the realistic economic outlook
1) Oil market stress is not a true reflection of the global economy
To start, I don’t see the oil market stress as a true reflection of the state of the global economy. Don’t get me wrong, the global economy is in pretty bad shape. As a reflection of this, the April flash composite PMIs (Purchasing Managers Index) were far worse than even our bearish expectations. Assuming unchanged readings in service sector PMIs not yet reported, we expect the April global services PMI is likely to be around 27. The bottom in the global financial was 38.
Chart 1: Forecast for April global manufacturing PMI (based on unchanged readings for countries yet to report): A reading near 40 looks likely, low but well above the 2008 global financial crisis (GFC) experience.
2) The flash manufacturing PMIs were a little better, especially from Asia.
Some modestly encouraging data from Asia is a key point to note in this story. Our estimate for the global manufacturing PMI is just below 40 in April (chart above). This is low, but not nearly as low as the services sector. Notably, other Asian data in March, Taiwan export orders for example, continue to imply the Asia cycle is faring better than in Europe and the US.
3) Metal prices are performing better than oil
This gap between depression-like service sectors and recession-like manufacturing has been echoed in the relative performance of oil versus industrial metals prices. Neither is positive, but metals are performing better than oil. In the coronavirus crisis, manufacturing is less impacted than services and will recovery more quickly, in Asia especially.
4) Big challenges face higher-cost oil producers
One thing I can say for sure is that the oil market stress will make it very difficult for higher-cost oil producers. It is a long list, but the three major ones to mention in our view are Canada, Colombia and Brazil. For Brazil, weak oil prices are only the start of the problems. Political tensions have been building in recent weeks and culminated in the resignation of the Minister of Justice a few weeks ago. The Supreme Court has now opened up an investigation of the President.
Don’t read too much into long-run inflation trend from oil prices
Another important and nuanced story around the plunge in oil prices is the impact it will have on inflation. While the impact on near-term consumer inflation is already significantly negative, it is not obvious that the stress in the front-end of the oil curve says a lot about inflation risks further out. Notably, 5-year Brent and even 5-year WTI (West Texas Intermediate) remain closer to $50 per barrel. Meanwhile, the oil price curve today is much steeper than in past crises (chart below). This should drive significant supply cuts near term, as markets are telling producers there is far more value in leaving the oil in the ground. It is already having a big impact, as recent supply cuts – especially in the US – have been very large. Net-net, today’s deflationary oil market is working its way to becoming tomorrow’s inflationary one.
Chart 2: WTI oil curve at start of year, start of April and now: Longer-dated prices still near $50 per barrel. Relative WTI weakness to Brent shows the supply glut is more acute in the US.
Stay tuned for more updates.