A return to ‘normal’ isn’t likely if ‘normal’ is no longer
When oil prices hit zero, it signaled just how outside the known universe we’re now venturing. A sunny afternoon, socially distanced, but with beers in hand, my neighbor, a historian, and I were talking about what negatively priced oil might mean. The first thing we agreed on was that you might make educated guesses, but only a fool would claim to know anything with much certainty. Here’s what we came around to.
Oil prices went negative because it costs money to store oil, and because you can’t simply turn off oil wells when the price plummets. Oil company revenue models expect wells to produce for decades into the future in order to recoup costs. This price drop represents a bet by investors that demand will stay perilously low for a long time after my neighbor and I can again stand next to each other at the grill.
After another sip and ponder we started musing about why oil companies didn’t expect demand to return to pre-COVID levels. We had a lot of ideas: people will commute less, factories will be relocated closer to markets, air travel will remain low because it will be harder to get visas, etc. In the end, one big fact was clear: investors with trillions of dollars riding on guessing right are assuming there will be large disruptions in consumer behavior for at least half a decade. At the end will be a world whose reliance on hydrocarbons to move people and goods is sharply lower.
So what might that world look like on a grand scale?
The central shift will be to dislocate the Middle East as the pivot of world affairs. Saudi Arabia and the other Gulf States are facing a sharp cliff. Their single-product economies will come under immediate stress. Governments have been trying to diversify their economies on the expectation this change will happen over decades. The virus has telescoped that timeframe forward by decades. The disruption will be so fast that it’s likely to stoke major social dissent, including terrorism. In turn, governments in the region often deflect blame by vilifying foreign states. For Sunni oil states that enemy is Shia Iran.
Iran is arguably in a better state to weather this crisis. It has a more diverse economy and stronger education system than its rivals. In part this is because the sanctions on Tehran have forced it to build a state less reliant on oil revenues. In a scenario where Sunni states rachet up threats, Iran may well accelerate its nuclear program. If that happens, Israel could threaten military action along with the U.S. So, one macro effect of an oil price drop is, predictably, a return to a deeply unstable Middle East.
One winner in this scenario is Turkey. It has a lever over the crisis in Syria (remember that?) and the broader Sunni/Shia rift. Istanbul also controls whether millions of refugees from Syria end up on European borders. Meanwhile, the EU is digesting both the impact of the virus and Brexit. A refugee crisis and a financially broken Italy, which already risked default, is the perfect mix to incite hard right anti-immigrant movements spurred by an immigration and debt crisis. The EU would face a survival crisis under these conditions.
China faces a loss of manufacturing as big firms diversify manufacturing sites. Mexico, Brazil, Pakistan and others probably will benefit. For niche U.S. firms, many factories produce parts in Chinese factories that supply the production engineering to mass produce items. These firms don’t have manufacturing expertise and it will take time to find it. One upside is that it may come from American sources instead.
We rocked back in our chairs, finished our beers and looked at each other. We didn’t have much of a clue what to expect, really. But if our backyard pontificating revealed anything, it was that we weren’t going back to “normal.” Normal didn’t exist anymore.