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Oil Price Drop11 March 2020

A large fall in oil prices has sent markets sharply lower at the start of this trading week. Oil producing equity markets, and the oil price were priced markedly lower in early trading after investors negatively assessed the events post the most recent OPEC meeting in Vienna last Friday.

At the meeting, Saudi Arabia stated that they wanted OPEC & Russia (not currently in OPEC but a major oil producer) to cut production to support oil prices. Saudi Arabia was concerned that Covid-19 and the on-going virus epidemic would have negative impacts on global oil demand and thus led to issues for oil production moving through 2020. These types of cuts are not new, and OPEC will engage in this type of action to help keep prices stable in a commodity whose price is driven solely by supply and demand.

Even though Saudi Arabia had its plan, what occurred was Russia’s refusal to cut any production and this then led Saudi Arabia to not drop its production but instead declare to increase it further and drop its own selling price. This led to a 20% drop in Crude Oil prices to less than $55 dollars per barrel. The sharp fall in price was mainly due to an increasing supply in an already saturated market.

The subsequent steep drop in oil prices makes it more likely that some oil producers will default on their debts sending bond yields higher and oil stocks lower. This could have an impact on the wider bond markets, given more than 10% of the US high-yield bond index is made up of oil producers. From an equity perspective, investors will be focusing on what impact a lower oil price will have on earnings and dividends.

In terms of the wider economic impact, a lower oil price could provide a modest boost to consumers. This will take some time to push through into the data and may possibly mean that the very short-term impact on the oil price and oil producers will be negative and put further pressure on equities and bonds.

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