Writing about global market developments at this moment in our shared history has been particularly challenging over the past couple of weeks. Denmark, like many other countries, is currently in a partial lock down while we watch the number of casualties from Covid-19 continue to grow, not least in Europe, the current epicenter, but probably soon in the US as well.
Working from home, trying to stay out of harms way, has been the right decision to adopt by governments. The flipside is the terrible cost in terms of lost revenues and pressure on smaller companies to stay afloat and to keep their staff on the payroll. Over the coming weeks and months we are going to see a dramatic jump in unemployment thereby signaling a temporary end to the good times that many have experienced during the past decade.
Governments and central banks have already stepped up and dozens of major bazookas have been fired in order to support individuals and companies. Perhaps we reached peak panic this past week, only time will tell. At least we’re seeing some stabilization emerging, not least from the stock market. For now, however, the strong dollar due to exceptionally strong demand and a broken bond market especially on the corporate side, highlights the challenging road that lies ahead.
Turning to commodities, the table below shows the damage inflicted on the sector so far this year. Crude oil, which is the glue that keeps the global economy going while also providing the main income for many countries and regions, has led the collapse. An extraordinary slump in global demand has opened up a 5 to 10 million barrels/day gap between demand and supply.
The price war started by Saudi Arabia two weeks ago combined with a continued drop in demand as countries grind to a halt and planes are grounded could see this gap potentially rise by another 5 million barrels/day from April and onwards.
The result of these developments has been an unprecedented oil price collapse which on Wednesday saw Brent crude oil touch $25/b for the first time since 2003. Compared with the average price of $65/b in 2019, the net reduction in payments from consumers to producers is currently close to $3.5 billion dollars per day.
Energy companies have suffered steep declines in their market cap during this time. With no letup in the price war, the attention has turned to the ability of heavily indebted production companies to survive this race to the bottom, especially in the US where binge borrowing and dismal returns on equity has left many smaller producers in trouble. It will become a race to the bottom unless drastic measures to curb supply are being implemented. The daily rise in storage could see tanks hitting peak capacity within months and such a development would eventually force production down. This however would be at a tremendous cost and pain to all, including Russia and Saudi Arabia.
What could change this race to the bottom would be the announcement of a production cut from the Texas Railroad Commission which regulates oil and gas production production in Texas, the world’s third largest production area. They have the authority to step in and order a reduction, just like they did in 1973. Such a move would dramtically increase the chance of dialogue and for Russia and Saudi Arabia to step back from the their war of words and war on price.
For the sake of the global economy and the wellbeing of everyone, both producers and consumers, the main focus over the next 12 months is to avoid reaching the top of the tank as the price would otherwise collapse. A production cut across the board of 10% would ensure that the oil market avoid this scenario. These are extraordinary times that requires extraordinary decision…
Finally, over the coming months the focus is likely to remain squarely on the price damaging impact of the dramatic drop in demand for many key commodities from crude oil and industrial metals to some agriculture commodities. But as the coronavirus continues to spread it is very possible that the supply outlook will become challenging as miners and producers begin to feel the impact of staff shortages and the breakdown in supply chains. The impact of lower fuel prices is being felt from agriculture to mining as it drives down the input costs. However, the potential risks to supply could see some markets find support sooner than the demand outlook suggests.
