The weekend falling out between Saudi Arabia and Russia has seen oil prices post their biggest one-day decline since the outbreak of the Gulf War in 1991, as markets price in a supply glut at a time when demand shows signs of slowing markedly.

In a statement out this morning the IEA said that oil demand was likely to fall for the first time since 2009. At any other time a decline in oil prices would be treated as good news for consumers and airlines more broadly, however all it has done is magnify concerns about the weakness in the global economy at a time when coronavirus cases have continued to rise across the world.

The lockdown in northern Italy, if replicated elsewhere, has raised concerns that any prospect of global growth this year is becoming increasingly unlikely, particularly as cases are rising across Europe, the UK and the US.

The slide in the oil price also has significantly consequences for the oil majors in terms of lower revenues and profits, with the share prices of BP and Royal Dutch Shell dropping over 20% on the open today.

With this in mind, the 2016 lows for Brent crude are likely to be a key level in terms of any prospect of a recovery. A break through these lows could well a sharp move towards $20 a barrel, and while enormously painful for all of the oil-producing companies, some have higher pain thresholds than others.

Russia probably won’t mind given the resilience of the rouble, while Iran is likely to suffer given it's suffering from sanctions and a coronavirus outbreak. It seems a solution lies in the hands of the Saudis in the short term, and whether they can persuade the Russians back to the table. That may take some time and a lot more oil price volatility before it happens.

Source: CMC Markets

Today’s sharp falls in the oil price also call into question the sustainability of BP and Shell’s dividends, which are both in excess of 10%. While this seems quite attractive, it also needs to be set in the context of share price declines year to date of over 35% for Royal Dutch Shell and over 30% for BP.

BP’s problems are particularly acute given their acquisition of BHP Billiton’s shale assets a couple of years ago, for $10bn. With a gearing of over 30% and a breakeven price of just below $50, a sustained period of lower oil prices is going to be painful and could well mean that shareholders might have to absorb a dividend cut.

As things stand with demand set to fall as airlines cut capacity and people travel less due to concerns about fresh coronavirus outbreaks, the longer-term outlook is likely to be constrained by the green agenda. This will present a clear challenge to these oil majors, who have to all and intents and purposes been well behind the curve in preparing their business models for a lower carbon world.

 

Disclaimer: CMC Markets is an order execution-only service. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although we are not specifically prevented from dealing before providing this material, we do not seek to take advantage of the material prior to its dissemination.