Oil Shock : The Indicator from Planet Money A spat between Russia and Saudi Arabia led to a collapse in oil prices over the weekend. Stock prices followed. What happened and what it means.
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Oil Shock

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Oil Shock

Oil Shock

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STACEY VANEK SMITH, HOST:

This is THE INDICATOR from Planet Money. I'm Stacey Vanek Smith.

CARDIFF GARCIA, HOST:

And I'm Cardiff Garcia. And today was quite a Monday.

VANEK SMITH: It was quite a Monday. But the trouble we saw today really started over the weekend in a fight about oil. So the oil industry has been struggling. Oil prices have been low for months.

GARCIA: Yeah, and whenever the economy slows down, the demand for oil also starts to slow down because there's less demand for goods to be flown or driven or shipped around the world. There's fewer people traveling, so that pushes down the demand for oil from what it would have been. And the price of oil drops.

VANEK SMITH: And that had already been happening, but then coronavirus hit. And demand for oil dropped off a cliff. So over the weekend, Saudi Arabia met with Russia. Saudi Arabia proposed cutting oil production. They thought, let's decrease supply for now until we see how coronavirus shakes out. That way, the market won't be flooded with oil.

GARCIA: Yeah, and that was intended to prevent the price of oil from falling even more. Russia and Saudi Arabia are two of the biggest oil producers in the world. So if they both cut production, there would just be less oil in the world.

VANEK SMITH: But Russia said, no. No way. We're not playing ball. We are producing all the oil we want. Too bad if there's a ton of oil on the market and the price collapses. They reportedly said in a meeting that it would damage U.S. oil producers to drive the prices low. So they wanted to drive the prices low.

VANEK SMITH: And Saudi Arabia was like, fine, OK. You want to play that game. If you won't cut production, then we are going to offer a big discount on our oil and drive the price even lower than you, the Russians, think it's going to go.

VANEK SMITH: And oil prices dropped about 25%, and the markets freaked out. They fell so much, so fast, it triggered a built-in trading stop. At the end of the day, the Dow Jones Industrial Average had seen its biggest one-day points drop ever and was down nearly 8%.

GARCIA: But why? Why did the drop in oil prices hit the markets so hard? And what does this mean for the oil industry and for the overall economy? Today, we speak with Stephen Schork. He's an oil trader and an analyst. He joins us right after the break.

(SOUNDBITE OF MUSIC)

VANEK SMITH: It's nice to hear your voice. I wish it were not under such crazy circumstances.

STEPHEN SCHORK: (Laughter). Yeah.

VANEK SMITH: First of all, thank you for making the time. Second of all, what has your day been like?

SCHORK: Quite bizarre. We have never seen a one-day move like this in the history of trading oil futures.

VANEK SMITH: Really?

SCHORK: That goes all the way back to 1983. So this is virtually a once-in-a-career day that we are watching in the oil markets today.

VANEK SMITH: Did you sleep?

SCHORK: Yes, actually. I - we're conservative, and we were prepared for this. I really thought and I was really kind of perplexed over the past month that everyone kind of seemed to want to downgrade the impact of coronavirus. And Wall Street analysts have a habit of, when there's an event occurring, they look back and try to find an analog, a similar event. And they watched how the market performed then, and then they try to extrapolate that how it performed today.

VANEK SMITH: Sure. Yeah. That feels like a very logical, human way to deal with uncertainty.

SCHORK: Exactly. Yeah, it's intuition. And so you had a lot of people going back, OK, this SARS epidemic in 2003, and we saw that - what the hit that SARS did to air travel and jet fuel demand and so forth. But the big difference was that in 2003, during SARS, China was 4% of the globe's GDP. Today, China is the second-largest economy in the world.

And so people, I just thought, lulled themselves in this false sense of security that, oh, this is going to be SARS, and we'll take a one-maybe-two-quarter hit and then we'll be on our merry way.

VANEK SMITH: Right.

SCHORK: And - but certainly that is not the play right now. And then of course with the hit that we know we're going to see in the fact that Russia did not play along with Saudi Arabia and cut production on Friday. And then that prompted Saudi to start this price war. I think that is just feeding in and just adding fuel to a raging fire.

VANEK SMITH: Well, I definitely wanna get to Russia, but just to sort of explain really quickly, the reason that oil is so tied into planes not flying, people not shopping, is that - oil is really tied into economic growth. So when economic growth slows down, when people aren't shopping or taking planes or trains or driving their cars places or traveling or business conferences get canceled, that really lowers the demand for oil and pushes the price down. So that's where we already were when Russia and Saudi Arabia met over the weekend, and then what exactly happened between Saudi Arabia and Russia?

SCHORK: So ideally, you had a gambit that was running by the Saudis, that the Saudis were floating a 1.5 million-barrel cut in production, and they could not get any sort of consensus or agreement with Russia to agree to partake in this cut. So you're now seeing two major oil-producing titans that are playing a significant game of chicken. And the Russians would not play.

VANEK SMITH: Russians are like, no, we're going to keep pumping oil at the same rate.

SCHORK: Exactly.

VANEK SMITH: That seems so strange to me because they're not going to get that much money for it if they're flooding the global market with supply. Like, what do you think? What do you think the reason would be?

SCHORK: Well, you know, there's a couple of theories. I'm skeptical of it, but clearly the U.S. shale producers are going to be extremely hit and hurt by this.

VANEK SMITH: Yeah.

SCHORK: But so too are countries like Iran and Venezuela, which are ideologically in the same bed as Russia. So I can't imagine targeting oil prices to say that I want to take out the U.S. shale producer when, quote, unquote, "my allies" are going to get hurt even more...

VANEK SMITH: Right.

SCHORK: ...Than me. And outside of - tongue-in-cheek - election manipulation or trying to hurt a U.S. shale producer that is already significantly hurt, it's anyone's guess as to what Moscow's ultimate goal here is.

VANEK SMITH: And if you don't mind explaining - so I think that that really explains really clearly, like, why oil prices fell so sharply. But then the markets, like, absolutely had a terrible morning. They had to halt trading because things were dropping so fast. Why does a decline in oil prices like this, like, really just shake the foundations of the market so much?

SCHORK: Commodity prices are one of your finest indicators, leading indicators of economic activity. And so when you see a significant plunge in the price of a commodity, be it copper, alumina, crude oil, heavy, industrial commodities - when you see significant price drops, that is a very good tell tale of extreme economic headwinds that we could be facing three, six, nine months down the road.

So anytime you see that significant pullback in price, it does send a shudder through the market because this is a leading indicator. And I think it was a move, a flight to safety. This is why U.S. Treasury prices have screamed higher.

VANEK SMITH: Oh, right. Everyone wants to - everyone wants to go into bonds now because Treasury bonds are seen as the safest investment there is. Even though you don't make a lot of money on them, at least, you know, you don't lose your money.

SCHORK: You - and that's just it. Now it's about capital preservation, not about capital growth.

VANEK SMITH: Is there a silver lining to all of this? Sometimes when oil gets cheaper, it helps consumers. Consumers have a little more money to spend. Is there...

SCHORK: No. There's never a silver lining when, you know, we might be paying sub-$2 gas at the pump this summer. But that deflationary impact of low oil prices is never a good sign because low oil prices are a sign of a weak economy. So it might - it will give you a sugar high, as it were, that it feels good to buy a $1.90 at the gallon. But you're doing that because the economy around you is extremely troubled.

VANEK SMITH: Is this all really coronavirus impact?

SCHORK: No.

VANEK SMITH: OK.

SCHORK: Coronavirus is exacerbating this. But the U.S. industrial economy, factory economy has been in recession for the last three, four months - same with the industrial economies in Europe and Asia. And this is more offset of the ongoing trade rift between Beijing and D.C. So you already were looking at depressed economic activity from the industrial side of the economy. Coronavirus now runs the risk of spreading this to the consumer side.

VANEK SMITH: Stephen, thank you so much for joining us.

SCHORK: I appreciate being here very much.

VANEK SMITH: Today's episode of the indicator was produced by Leena Sanzgiri, fact-checked by Britney Cronin, edited by Paddy Hirsch. And THE INDICATOR is a production of NPR.

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