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Oil-price war seen exacerbating slump in global economy

There are few upsides to $25 oil during a pandemic.

Previously when oil prices have slumped by 50% or more, in 1986, 2008-09 and 2015-16, GDP growth was given a boost as lower energy prices allowed households more discretionary spending. With a barrel of Brent crude down by more than 60%, consumers would have see quite a windfall, in normal times.

Capital Economics calculated that a sustained drop in the price of oil to $35/barrel will lower OECD inflation by about 1 percentage point. But with the economic consequences of coronavirus expected to include a substantial reduction in consumer demand, lower oil prices will likely hinder rather than help the world economy.

"If anything, it has raised the threat of a deeper downturn," Jennifer McKeown, head of global economics service at Capital Economics, wrote in a research note.

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A combination of weak demand owing to the economic fallout from the coronavirus and an increase in global output as Saudi Arabia launched a price war following the breakdown of production talks between OPEC and Russia has seen the price of Brent crude oil slump from $65.92/barrel on Jan. 1 to a closing low of $24.88 per barrel on March 18, the lowest level since September 2003.

US shale 'bloodbath'

Net importing countries such as China and India will be the biggest beneficiaries of low oil prices, but with large swathes of both those countries under lockdown, the effect on consumer spending is likely to be negligible.

By contrast, oil producers will be significantly impacted.

The U.S. shale oil industry was in the sights of Russian and Saudi Arabian oil planners as they prepared to allow prices to slump. U.S. shale producers have thrived amid previous OPEC agreements to curtail output and support prices, but with prices falling far below cost for many producers, economic activity in the sector will be severely restricted.

"We could well see a bloodbath in the U.S. shale industry," Michael Hewson, chief market analyst at CMC Markets UK, wrote in a research note.

Average break-even prices for shale oil production across the U.S. range from $48 to $54 a barrel, according to the Dallas Federal Reserve.

"The current prices… will grant smaller U.S. shale oil producers only a short amount of time during which they will be able to continue operating," Matt Weller, global head of market research at GAIN Capital, said in an email.

Sustained price pressure will lead to layoffs, while the scaling back of capital expenditure and investment will shave 0.3 percentage point off U.S. GDP, according to Oxford Economics.

Oil patch ripples

Problems for oil companies have repercussions for the wider economy. Some U.S. banks with significant exposure to the oil sector were already having credit quality issues last year, and the recent drop in oil prices could lead to more delinquencies.

Banks headquartered in Louisiana, Texas and Oklahoma have seen their stock prices fall sharply in response.

As a portion of total loans, Tulsa, Okla.-based BOK Financial Corp.'s 18% energy exposure was highest among the banks analyzed. Of banks analyzed by S&P Global Market Intelligence, Bank of America Corp. had the most total energy loans, but the exposure was only 1.7% of total loans.

Click here to access a spreadsheet listing select U.S. banks with energy loan exposure.

Consumer savings

Any savings to households are unlikely to be funneled into other areas of the economy.

"While plunging oil prices traditionally boost consumer spending, the financial market turmoil and uncertainty triggered by COVID-19 will likely lead consumers to save most of their gas windfall in the near term," wrote Lydia Boussour, senior U.S. economist at Oxford Economics, in a research note.

Household spending is the beating heart of the U.S. economy. Personal consumption accounted for 68.1% of the country's GDP in the fourth quarter of 2019, according to the U.S. Bureau of Economic Analysis, a figure that has been broadly unchanged since the turn of the millennium.

The impact of the coronavirus on U.S. consumer confidence started to show in the University of Michigan's latest release on March 13 when its gauge fell from a two-year high of 101 to a 95.9, the lowest level since October 2019. However, most of the severe measures to enforce social distancing were not in place when its survey was carried out and investors will be closely watching its next release on March 27.

OPEC blues

With Saudi Arabia's Ministry of Energy directing state-owned energy company Saudi Arabian Oil Co. to continue to produce crude oil at higher volumes over the coming months, prices are seen staying low and the effect on government revenues is likely to be severe. That would, in turn, crimp the ability of Saudi Arabia and other oil-dependent economies to ramp up spending to counter the effects of the coronavirus-induced economic slowdown.

"Current oil prices are significantly below the fiscal break-evens for all of the OPEC producers. It is difficult to envisage that these prices can be sustained without significant cuts to fiscal programs, which in turn would lead to significant unrest," Mark Lacey, head of commodities at Schroders, said in an email.

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Saudi Arabia's fiscal budget for 2020 requires oil prices of $78.30 a barrel, according to the IMF, while in Russia it is about $50 a barrel, still twice the current price.

Oil-dependent Latin American economies will also be heavily impacted. When the price of a barrel of oil last fell to $30 in 2016, the region fell into recession. Oxford Economics ran a model assuming oil stays below $40 a barrel until the end of 2021 and found that GDP growth will fall 0.7% in both 2020 and 2021 from the original forecast.

"With public debt on the rise in most countries, we found that governments are unable to use countercyclical fiscal policy to cushion the downturn," Marcos Casarin, chief LatAm Economist at Oxford Economics, wrote in a research paper.

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