Overnight: Beyond -2000

By Greg Peel

Oil Wars

It had been anticipated that were Russia not to agree to OPEC’s proposed additional production cuts of -1.5mbpd the oil price would plunge, and indeed it did on Friday night by -10%. What no one saw coming was Saudi Arabia’s response.

If Russia is going to go it alone, so is Saudi Arabia. OPEC and Russia got together to agree on production cuts after the oil shock of 2016, which was driven by the spike in US shale production. Those production cuts had held ever since, right up until Friday when further cuts were proposed by OPEC. When Russia said no, not only did this imply the additional cuts would not occur but that the prior cuts are now out the window. The agreement expires on April 1.

Saudi Arabia will now fight on volume over price. One might assume OPEC is dead in the water. Russia, it is assumed, has become fed up with carrying the can and wants to break the US shale industry. The Saudis don’t want to have to carry the can alone. The Saudis can produce oil at a cost of US$20/bbl. For Russia it’s more like US$40/bbl. For marginal US shale producers, the cut-off is above US$45/bbl.

Saudi Arabia’s and Russia’s oil industries are state-owned (the Aramco float is negligible) and both carry large cash war chests for just such a development. The US oil industry is free market, and for many smaller operations, heavily leveraged.

The Fallout I

LNG export prices are indexed to the crude oil price. The most leveraged of Australia’s big oil & gas producers is Oil Search ((OSH)), hence yesterday it fell -35%. There followed Santos ((STO)) on -27%, energy industry contractors NRW Holdings ((NWH)) and Worley ((WOR)), with -20% drops, and Beach Energy’s ((BPT)) -19% rounded out the top five ASX200 losers. Australia’s biggest O&G company by a margin, Woodside Petroleum ((WPL)), fell -18%.

The energy sector fell -20%. All other sectors fell in a distinct range from defensive to cyclical. Utilities fared best with a -2.1% fall. Materials came in behind energy with -9.5%, which is interesting given the amount of fiscal stimulus about to hit the planet, but we recall BHP Group ((BHP)) is also an oil producer, and it fell -14%. Rival Rio Tinto ((RIO)) which is not in oil, fell only -6%.

The IT sector took bronze with -9.0% and then we drop down to the banks on -7.6%. Another RBA rate cut in April is now considered a given, and NAB economists are predicting QE by May. The risk of a recession is now also heightened, which could break the long run of benign bad and doubtful debts levels for the banks.

All other sectors fell by diminishing amounts by level of defensiveness.

To underscore the widespread nature of the selling yesterday, the ASX200 top five leaders’ board only had three stocks on it, because only three of two hundred closed in the green.

Fisher & Paykal Healthcare ((FPH)) recently upgraded guidance due to virus-driven demand for its medical products in China. It rose 3.0%. Newcrest Mining ((NCM)) gained 2.5% as gold held its ground, while utility infrastructure company Spark Infrastructure ((SKI)) rose 0.5%.

The ASX200 fell -7.3% yesterday ahead of the S&P500 falling -7.6% overnight. One would assume, thus, that we got in first and another big drop in response to Wall Street would be double-counting.

Our futures are down -273 points this morning.

The Fallout II

The world has seen many oil shocks over the years, either demand-driven, such as the airline shutdown following 9/11, or supply-driven, such as the OPEC shocks of the 1970s and more recently the US shale explosion of 2016. But last night oil industry veterans could not recall oil markets suffering a simultaneous hit on both sides.

Typically a big fall in the oil price would lead to buying elsewhere in those sectors that benefit, such as airlines and transport, for which oil is the primary cost, through to consumer discretionary, which benefits from more money in consumer pockets. But last night everything was trashed on Wall Street.

Lower oil prices are no comfort, at least not yet, to US transport companies when no container ships are arriving from China. There’s no comfort for airlines when their planes are grounded and no one’s flying. If retailer shelves are emptying due to factory shutdowns in China, there’s nothing to buy, even if consumers felt it a good time to do so, which given recession talk, they probably don’t.

When Wall Street opened last night trading was only ten minutes in when it shut down again. The -7% circuit breaker was tripped, halting trade for five minutes. It worked, to the extent that the market calmed down. I’d wager that the computers were confused by a circuit breaker – many being too young to recall the last one (GFC) – hence from thereon trading was described as “orderly”, despite the Dow ultimately closing down over -2000 points.

When Wall Street was halted, the US ten-year bond yield was hitting 0.32%. That was a -39 basis point fall. The yield quickly rebounded, presumably as investors sold bonds to cover stock losses, and ultimately the ten-year closed down -21 points at 0.50%.

While the energy sector was clearly the worst performer on the day, the banks were close behind. There’s not a lot of earnings upside when the cash rate’s 1.0% and ten year’s out is 0.5%. But there is also the small issue of smaller US oil companies being highly leveraged.

While the US majors have minimal loan exposure to the industry, some smaller regional banks are heavily exposed. Long before the virus even appeared, the greatest level of concern in US credit markets was reserved for oil companies.

Putin knows that.

Only a handful of S&P500 companies closed in the green last night. Smaller oil companies fell as much as -50% in the session. Only one Dow stock closed in the green – Walmart, seller of toilet paper.

And right now, everyone’s ______ themselves.

Commodities

Metal prices should, in isolation, be supported by a plunge in the US dollar and the promise of global fiscal stimulus, but not if the world is headed for recession.

Why has gold stopped dead when it should be surging? Likely because buyers are crashing into those selling to cover losses in other markets, particularly in the case of margin calls.

While oil prices this low have been seen before (US$26/bbl in 2016), a one-day -25% price drop is unique.

Something weird happened in the Aussie yesterday, but in the wash up it’s down only -0.4% over 24 hours to US$0.6586, dampened by a -0.9% fall for the US dollar index.

Today

The SPI Overnight closed down -273 points or -4.8%. Yesterday the ASX200 closed down -19.5% from its all-time intraday high set in February. Stand by for media reports to become rather grizzly.

The Australian share market over the past thirty days…