(Bloomberg) -- Another shockwave is about to rip through a world economy already reeling from the coronavirus.
Oil prices plunged after the dramatic breakdown of talks between OPEC and Russia prompted Saudi Arabia to launch a price war. Brent crude tumbled by almost a third to $31 a barrel on Monday, as Goldman Sachs Group Inc. told clients it could quickly dip into the $20s.
Such an extraordinary slump, if sustained, would savage national budgets from Venezuela to Iran, threaten the heartland of America’s shale revolution and upend politics around the world. For central bankers, the prospect of destabilizing prices are an added complication as they try to model the impact of the coronavirus epidemic on the economy. And a long period of cheap oil prices could even hurt the fight against climate change by slowing the transition to renewable energy.
“Something like this could have more global repercussions than a trade war between China and the U.S. because oil touches so many things in the world economy,” said Rohitesh Dhawan, director of energy, climate and resources at Eurasia Group in London.
There are winners from rock-bottom oil prices -- among them China, the world’s largest oil importer, whose recovery from the virus will be key for the global economy.
But this time is different. The U.S. -- once a winner from low oil -- is now an exporter rather than a buyer. And the hit to economic demand from the virus dulls the impact of any stimulus that cheap oil might provide. Oil shocks -- on the way up -- used to be feared for their impact on inflation. Now in a world where central bankers desperately pursue price growth, the opposite dynamic is at play.
“Lower oil prices will still not get people back in trains, planes, and automobiles, and stimulating the economic sectors most heavily hit,” said Stephen Innes, chief Asia market strategist with Axicorp Ltd. “But now we have a financial disaster brewing in the form of the shale industry meltdown.”
Russian Strategy
The crisis was precipitated when Russia refused to yield to a Saudi-led gamble to force Moscow to join OPEC in production cuts. OPEC presented a take-it-or-leave-it plan to slash production and throw a floor under prices. But Russia had another idea: its strategy was to squeeze American shale producers, which have flooded the market in recent years as OPEC+ nations held back their own production.
Now many of those U.S. operators will be losing money on every barrel of oil they produce and, unless there’s a dramatic recovery in the price, face bankruptcy. Even before Friday’s catastrophic meeting, banks were expected to restrict lending to shale drillers and a chunk of high-yield energy debt is already trading at distressed levels.
The last bust in the U.S. shale industry -- when prices went as low as $26 -- contributed to a manufacturing recession in 2016, when industrial regions, many in states likely to swing this year’s presidential election, saw a slowdown in orders from new shale oil projects.
Russia was willing to walk away from talks with OPEC in order to hurt U.S. rivals as it’s more resilient to lower prices. It has a floating currency -- unlike Saudi Arabia -- and can sustain its budget with lower oil revenues.
“Russia and President Putin are in a better position to fight this war than is Saudi Arabia or its Crown Prince,” said Chris Weafer, CEO of Macro Advisory, a Moscow-based consultancy.
The threat of economic -- and even political -- self-harm didn’t dissuade Saudi Arabia from launching a price war on Saturday in response to Russia’s refusal to cut production. But crown Prince Mohammed bin Salman will see his plan to retool the economy undermined as he moves to cement his political dominance.
Aramco Rout
Saudi Aramco -- the national oil company listed on the stock market last year in a deal that put the prince’s credibility on the line -- saw its shares plunge 9% on Sunday and another 10% on Monday in a sign of the instability ahead.
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