Oil Crash Sends Shock Through Virus Crippled World

“Oil prices at sustained lows of $40 for five years is crisis time in Oman first, then Saudi Arabia and Bahrain, with defaults, peg devaluations, hefty spending cuts and higher taxes, with deep recessions and insolvent banks,” said Rory Fyfe, chief economist at MENA Advisors. At $20, it would force political change in Saudi Arabia and the region, he said.

The crash means Gulf powers may also end up with less cash to spend on conflicts in the wider region, according to Steffen Hertog, a Gulf specialist at the London School of Economics. That could favor Russia, which has been playing an increasingly prominent role in the region.

More immediate will be the shock to oil majors such as BP Plc, and their response will have ramifications well beyond their investors. Chief Executive Bernard Looney is trying to transform his company in the face of climate change, while also reducing debt and maintaining a generous dividend.

The payout is all but sacred — as it is for Royal Dutch Shell Plc — though market gauges already indicate investors doubt it’s sustainable. Looney vows he can maintain the dividend and become a greener company at the same time, though he underlined last month the need for a healthy oil and gas business to fund the transition. A price crash will push balance sheets to the limit.

“Sharply lower oil prices for a sustained period with a concurrent OPEC+ driven supply shock and virus demand shock almost certainly means oil majors’ energy transition plans and climate ambitions will be obstructed or slowed, at least in the near-term,” said Will Hares, an analyst at Bloomberg Intelligence. “In the face of oil at $40 or lower, these companies will be battening down the hatches. The first priority is protecting the dividend.”

The crash imposes another body blow for credit markets, thanks to the energy industry’s outsize share of U.S. high-yield securities. America and Europe were already shutting down to new debt issuance, and the oil crisis now threatens to trigger an outright funding squeeze should distressed borrowers prove unable to roll over maturing debt. Premiums on U.S. junk bonds soared last week to 550 basis points over Treasuries, the highest since 2016.

Going Green

A slowdown in green plans isn’t the only risk the price crash could pose for the transition to a cleaner economy. Cheap fossil fuels tend to encourage their use — increasing emissions — and dissuade users from switching to alternatives.

On the flip side, lower oil prices could allow governments to cut subsidies and increase taxes on fossil-fuel consumption and use revenues to invest in renewable projects, said Ivetta Gerasimchuk at the International Institute for Sustainable Development. And for Europe — which is leading the charge on climate change policies — the impact of cheap oil is still an economic boost, potentially giving governments more room to fund green projects.

The key question is how long the rout continues. OPEC+ members appear to be keeping the channels of communication open and Russian Energy Minister Alexander Novak said the alliance wasn’t dead even as he swept out of Vienna on Friday, leaving his counterparts in shock. But each side wants the other to blink first.

“The Saudi intention is to force Russia back to the negotiating table by engineering an oil price collapse. Most structural indicators suggest, however, that Russia is more resilient to lower oil prices than Saudi Arabia, so it’s not clear this will work,” said the LSE’s Hertog, author of ‘Princes, Brokers, and Bureaucrats: Oil and the State in Saudi Arabia’.

“In the end, this will be Putin’s decision, but we could be in for a lower-for-longer oil price scenario.”