When it rains it pours, and it could soon be raining oil. Monday has the potential to be one of the worst days of this correction, and it isn’t a Coronavirus development that is at the center of it. Talks between Saudi Arabia and Russia collapsed over the weekend, where the Saudis, along with the other OPEC members, sought to cut production by 1.5 million barrels per day through the rest of 2020 to stabilize prices amid the demand shock caused by Coronavirus. Russia, a non-OPEC member, rejected the proposal, saying that it was too early to project the potential economic damage from the virus. An Iranian energy official described the meeting as the worst he has seen in 30 years.
The Saudis reacted by going with the proverbial nuclear option. They announced that instead of cutting 1.5 million barrels per day they will instead ramp up production by up to another 4 million barrels. If they go through with this move, the oil market will experience an unprecedented simultaneous supply and demand shock. As of writing, oil is trading down 20% and the US stock markets are pointing to a down -5% open. It is a possibility that unless postures change, we could see oil approach $20 in a matter of days. The major concern is that the high yield index, and both the HYG and JNK ETFs, have over 10% allocations to energy and the economy is already under significant stress from the virus concerns.
However, unlike the Coronavirus, this crisis can be solved in a matter of minutes. The ball is entirely in Russia’s court, and make no mistake, Russia would be causing severe injury to their own energy sector if they choose not to acquiesce to the Kingdom’s demands. I want to stress that any news of an agreement will almost certainly send the market sharply higher, but their position does beg the question: is Russia’s more pressing geopolitical strategy sowing chaos in the US economy, and consequently damaging the US dollar leading up to to our election? Russia is largely “de-dollarised”, and a weak dollar puts them at an advantage. There is undoubtedly some complicated things happening behind the scenes here. Stay tuned.