Saudi Arabia’s oil price war hits markets

Posted by Liz Rees in Latest insights category on 09 Mar 20

Saudi Arabia goes it alone

The oil price collapsed by more than a fifth as it became clear over the weekend that Saudi Arabia plans to launch a price war. The move caught markets by surprise and this morning panicked investors sent share prices tumbling as they rushed to safe havens to protect their capital. 

Saudi Arabia’s actions seem to have stemmed from a disagreement with Russia, which refused to make any cuts in production and instead wanted to wait and assess the impact of the coronavirus.

The Russia-Saudi alliance has floundered and there are serious implications for higher-cost producers worldwide. The US shale industry is particularly vulnerable due to high levels of debt and lower profitability.

Will the global economy fall into recession?

This is undoubtedly a worrying time and clearly some investors are panicking. However, central banks have been swift to act to support their economies.

The US Federal Reserve was one of the first to cut interest rates and Congress passed a bill for $8.3bn of emergency spending. Economists have slashed the odds on the Bank of England following suit.

However, lower interest rates do not help if consumers aren’t spending and businesses won’t need cheap credit if they can’t manufacture any goods! Earnings growth is essential to drive share prices and this may be hurt, at least in the short term. We believe that the stimulus should boost confidence when things return to normal.

With regard to the oil price, as ever, there are winners and losers. A depressed price will hit the profitability of the oil industry but should benefit the global economy overall through operating cost reductions for the transport industry and manufacturers that depend on oil. Many consumers could see their disposable incomes rise if petrol prices fall, increasing their capacity to spend.

A good time to invest?

It is impossible to say how long the weakness in stock markets will last but many professionals are treating it as a buying opportunity. Seasoned investors look for mispriced shares rather than trying to second guess geopolitical factors.

Markets always worry about something, from trade wars to climate disasters, but when these events dissipate or are resolved, recovery can be rapid. Only in January, worries about growing tensions in the gulf region caused a short-lived spike in the oil price.

Royal Dutch Shell and BP both fell heavily this morning, with their yields reaching double digits. This may have tempted some investors, although we can’t be certain their dividends will be sustainable should the outlook deteriorate. A fund with significant exposure to the oil majors is Morningstar silver-rated JOHCM UK Equity Income.