Oil and the state of global markets heading into April
Good Friday and Easter Monday put the brakes on global trade in equities, currencies, commodities and indices. Trading activity on Wall Street ended early on Thursday afternoon with the Dow Jones Industrial Average closing at 17,515.73 (+13.14) for a gain of 0.08%. For the past year, the Dow Jones is down 1.14%. The S&P 500 index closed at 2,035.94 (-0.77) for a loss of 0.04%. The NASDAQ Composite Index closed on Thursday, March 24, at 4,773.51 (+4.64) for a gain of 0.10%.
However, major averages across Europe were largely negative, with the Euro Stoxx 50 closing 1.83% lower at 2,986.73, the FTSE 100 closing 1.49% lower at 6,106.48, the DAX 1.71% lower at 9,851.35 and the CAC 40 closing 2.13% lower at 4,329.68. While European markets were languishing with poor performance (Brexit concerns and the twin terror attacks in Brussels), major averages across the Pacific were doing quite well. The Nikkei 225 gained 0.65% to add 110.42 points on the day to close at 17,002.75. Likewise, the CSI 300 gained 0.50%, up 15.97 points to close at 3,197.82. And lastly the MSCI AC Asia-Pacific index gained 0.36% to close at 127.88 for a gain of 0.46 points.
Crude oil remains front and centre. Over Easter weekend, US motorists were given another reason to celebrate with the lowest fuel costs in 12 years at the pump. Gasoline prices averaged $2 a gallon across the nation and this translated into savings of $9 bln for US motorists since January 1, 2016 (year on year). This translates into $45 per driver in savings, despite increased gasoline consumption in the first quarter of 2016. Year on year, the cost per gallon was vastly different: prices between January and March 2015 averaged $2.42/gallon, and when we extrapolate two years back, the price was approximately $4/gallon.
Remember that crude oil was priced at $105 a barrel back in June 2014 and it declined to as low as $27 a barrel in January 2016. The dramatic drop in the fuel price has been spurred by shale oil production in the US. This has resulted in a massive spike in global production as OPEC and nonOPEC countries compete with one another for market share. The virtual collapse in the price of crude has brought about widespread deflationary fears in the economy, and weakness in the price of oil is only now starting to turn the corner. From its January lows, crude oil is now hovering around $40 per barrel, leading the mini-resurgence for the global economy.
The Saudi Arabians have now adopted an upper and lower price range for the price of Brent: $20 on the low end and $40 on the high end. In January 2016, the Saudi Arabians were actively campaigning for a freeze on oil production in order to stabilise prices. Back then, oil was priced dangerously low and was heading towards $20/barrel, perhaps less. With oversupply dogging the markets, the only possible way to raise crude oil prices is to limit supply. The Saudis and the Russians got together with other oil producing countries from OPEC to discuss a production freeze when they met in Doha. Those plans were subsequently scuttled as Iran – a major oil producing nation – vowed to do no such thing. The Saudis followed suit and do not wish to sacrifice market share at the expense of a potential price rise in oil.
For now, Saudi Arabia will do everything in its power to prevent the price of crude oil from rising too much above $40/barrel because that level makes it lucrative for American oil producers – shale oil producers – to re-enter the trading arena. The long-term effects of increased participation of American oil companies is the degradation of OPEC and oil prices. However, there is an alternative school of thought that states the Saudis are quite happy to keep oil prices depressed because the Russians and the Iranians are using proceeds from oil to fund extremist groups that are intent on destabilising or overthrowing the Saudi Arabian regime. But the fact of the matter is that a price freeze among four major oil-producing countries, including the Russians and the Saudis, is insufficient to make a dent in the global supply/demand conundrum.
Saudi Arabians is facing a damned if you do, damned if you don’t scenario. If the price of oil rises too high, it entices shale oil producers to increase their productive capacity, and it also provides boosted revenues to Saudi Arabia’s nemesis – Iran, a clearly an untenable situation. The flipside is equally worrisome for the Saudis; low oil prices mean that it is burning through its vast forex reserves and depleting what was once a healthy surplus. The preponderance of low oil prices means that the kingdom will be unable to make good on its social welfare commitments which are already taking severe strain.
The fiscal and social budgets of Saudi Arabia require an oil price of $80 or more per barrel in order to be balanced. In 2015, the Saudi budget deficit spiked as much as $90 bln. Since 2000, the costs of the social programmes in Saudi Arabia have risen dramatically, and this is a source of concern for the kingdom which relies on high oil prices to maintain a balance. At the present time, it is not entirely clear what would be most beneficial to Saudi Arabia, perhaps a price that prevents the enemies of the kingdom from funding extremist and divisive elements intent on uprooting the political order, and the maintenance of social programmes which have now become pivotal to the survival of the political hierarchy.
The price of WTI crude oil spiked in June 2008 to $138.91 a barrel, but quickly plunged to as low as $33.17 a barrel by December 19, 2008. The upward climb then kicked into high gear as the price of WTI crude increased to $109.62 on September 9, 2013, and stabilised, dropping slightly to $107.49 on June 13, 2014 before plunging to $29.71 on February 8, 2016. If we extrapolate back to January 2, 1986, the price of crude oil per barrel was $25.56, and today’s price of $39.46 is just 33% higher than the price 30 years ago.
Of course, the price of crude is influenced by factors such as demand and supply, as well as the strength of the USD. The weaker the dollar, the greater the demand for crude oil since it is a dollar-denominated commodity. We have seen several interesting developments taking place with the USD of late. For starters, the Fed made an announcement on March 16 that it would likely only issue two interest rate hikes for the year. This suppressed the dollar rally and allowed for emerging market currencies to soar. This is also good news for the price of crude and for inflation targets to be met in the US and worldwide.
The recent terror attacks in Belgium sapped confidence out of the currency market, which is already languishing under poor liquidity. The safe money exited Europe and found refuge with the USD, giving rise to a strengthening US dollar, as evidenced by the resurgent US dollar index. However, this does not bode well for the price of crude and other dollar-denominated commodities. Since foreign countries find it more difficult to purchase crude oil in USD when their currencies are relatively weaker, demand decreases. We have seen a dramatic weakening in the price of crude oil for the days leading into the Easter weekend. Dollar weakness will be bolstered by a Federal Reserve Bank interest rate hike in April, if it comes to pass and this will keep oil prices depressed for quite some time.