*By Christophe Barraud, Chief Economist & Strategist at Market Securities
1- Latest indications suggest that Saudi Arabia is now ready to cut prices and increase its production dramatically in order to fight other exporters (including Russia) in terms of market share, which implies that oil exports from other countries (less competitive due to higher breakeven) will be under pressure soon. As a matter of fact, Saudi Aramco CEO Amin Nasser said on Tuesday that the company will raise its crude supply to 12.3M bpd in April (up from <10M bpd in February according to Bloomberg data).
2- A sharp shock in oil prices could be followed by geopolitical tensions.
3- Oil prices are likely to remain low longer than expected which would be immediately positive for advanced economies, mainly net importers.
4- However, with WTI below 45$, in North America, banks will be obliged to limit loans to shale gas companies which should result in tighter credit conditions and potentially defaults. As a reminder, energy companies are the biggest issuers of junk bonds, accounting for more than ~11% of the US high-yield market. In addition, Barron’s underlined that $13B of high yield energy bonds, equivalent to ~7.2% of the energy bonds in the ICE BofA-ML High Yield Bond index, will come due by the end of 2021. In this context, TrackInsight data showed that cumulative flows concerning “High Yield Bonds” ETFs already turned negative in late February.
5- It would also lead to significant CAPEX and job cuts in oil sector and therefore raises concerns that several countries such as the U.S. or Canada could face a technical recession because the coronavirus has already weighted on growth.
6- The other problem is that oil capex are import-intensive while oil exporting countries will be also forced to cut other public spending in order to balance budgets. It should lead to downward pressures on global trade growth (in volume) later so that it will probably decline again in 2020 (v -0.4% in 2019 according to CPB data).
7- Furthermore, fewer petrodollars in circulation would remove one of support for risky asset prices. As a result, the negative feedback loop could weigh on consumers through the wealth effect (especially in the U.S.).
8- Tighter credit conditions in the U.S. oil industry, recession fears and deflationary pressures (through gasoline prices) would offer more room for the Fed to cut rates. Next meeting is scheduled for March 18th.
9- Based on market conditions, it suggests that China will have less interest in buying U.S. energy products and reinforces my view that Beijing won’t meet both 2020 and 2021 targets defined in “Phase One deal”.
10- A lot of countries now appear vulnerable to a technical recession (2 straight quarterly contractions). At the global level, my proxies already signal that global GDP growth will contract in 1Q20 and won’t exceed +2.2% (IMF reference) over 2020 (vs +2.9%e for the Bloomberg consensus). It’s important to highlight that risks are still skewed to the downside and a print below 2.0% can’t be excluded.