Stocks plunge; Dow drops 2,013 points in Monday trading
Oil prices plummeted over the weekend after Russia rejected OPEC-proposed production cuts, setting off an oil-price war with Saudi Arabia. Futures for West Texas Intermediate (WTI) crude fell below $28 on Sunday, and WTI settled at $30.99 in Monday trading.
Oil prices had already fallen sharply this year because of factory closures and reduced travel caused by the coronavirus that originated in China and is now spreading in Asia, Europe, and the United States.
OPEC had sought production cuts to support prices in the face of weakening demand, but negotiations broke down Friday when Russia refused to cut production. Saudi Arabia then retaliated by slashing its asking price for April deliveries and threatening to increase its own production by 2 million barrels a day.
The world oil market, ~100 million barrels a day, is hypersensitive to small changes in supply or demand. The market has been oversupplied since 2014, partly due to the U.S. fracking boom, and the impact of coronavirus on oil consumption exacerbated the oversupply in recent weeks.
It’s a game of chicken with potentially huge consequences. Russia gets two-thirds of its export income from gas and oil, and depends on oil revenues for over half of its government expenditures. The Saudi kingdom needs high oil prices to support its social spending that buys political stability. This could bankrupt and topple unstable regimes in Iraq and Iran, and there will be ripple effects in the U.S. economy, too, if the two countries don’t quickly resolve their differences. Motorists and airlines will benefit from cheaper fuel, but that puts many of the roughly 800,000 jobs in the U.S. oil industry at risk, and a wave of loan defaults in the oil patch combined with coronavirus impacts on businesses and consumers could trigger a U.S. recession.
The already-battered U.S. stock market reacted badly on Monday, with the major indexes falling more sharply than at any time since the 2008 financial crisis. The Dow Jones Industrial Average (DJIA) dropped more than 2,000 points in Monday’s trading. Much of this is due to renewed recession fears. Bank stocks were among the hardest hit, because of the banks’ heavy loan exposure in the oil patch.
The impact in bond markets also was severe, with the 10-year Treasury falling to an unprecedented 0.56% on Monday, after going as low as 0.25% on Sunday. The Federal Reserve, which had already cut interest rates half a percent last week in response to the growing coronavirus crisis, and other central banks may consider intervening in bond markets.
In recent years, the U.S. has ramped up shale production, and become the world’s largest oil producer, but none of that shale oil is profitable below about $30, which could prompt many U.S. shale producers to shut in wells, suspend drilling operations, and lay off oilfield workers. Some may go bankrupt and default on their loans, with spillover into the U.S. banking industry and bond markets, although most financial experts don’t believe the effects would be severe enough to trigger another financial crisis on the scale of 2008.
Image: Two of the guys in this photo just plunged global finances into chaos, and the tall blond guy in center-left may be screwed politically if the U.S. falls into a recession as a result. The guys on the left aren’t smiling, but do you see the Saudi guy on the right smirking?