A falling oil price is a double-edged sword for WA.
Get ready for a pleasant surprise next time you fill your tank at the bowser, with the price of petrol and diesel likely to be a lot lower than last month (an observation straight from the category known as putting lipstick on a pig).
Oil has crashed, although most people have been too busy keeping an eye out for a stray coronavirus to notice. The commodity that determines the price of just about everything else has tumbled close to the $US30 a barrel range, half what it was 18 months ago.
The last time oil went below $US30/bbl was 2002 thanks to a sharp increase in US interest rates, which triggered a recession in that country and dampened worldwide fuel demand.
Economic conditions are far more fragile this time around thanks to depressed demand as entire sections of major countries, such as China and Italy, are quarantined, and oil cartel OPEC heads towards a possible collapse: an event that could unleash a price-killing flood of oil.
For Western Australia, the prospect of an oil price at $US30/bbl or lower is a double-edged sword.
On one hand it cuts transport costs in a state that has always suffered from the high costs of long communications lines.
On the other it raises doubts about plans to expand the state’s liquefied natural gas industry, because LNG is ultimately priced in comparison with oil and a falling oil price hits the revenue and profit assumptions underpinning Woodside Petroleum’s Scarborough and Browse LNG projects.
Multiple factors lie behind the oil price crash, which started with the US versus China trade war (remember that?), followed by a sharp fall in demand as fear of the coronavirus spread from China.
Those demand-depressing factors were magnified by what could become an oversupply crisis after what appears to be a breakdown of a deal between major oil producers to limit output.
The demand factors are bad enough and can be clearly seen in a dramatic decline in international travel, with cancelled flights helping cause the collapse of Europe’s biggest cut-price airline, Flybe, and the threat of more to come.
The oversupply issue is just developing and is yet to catch the eye of most investors because it was only triggered in Vienna on March 7 and 8, when talks between OPEC and Russia collapsed over a disagreement about whether to make a fresh round of production cuts to cope with the demand decline.
OPEC, led by Saudi Arabia, reckons more supply cuts are needed to stabilise the market and hopefully get the oil price back up to $US60/bbl.
Russia says the cuts are already too deep. It favours the removal of all artificial production obstacles to create a ‘survival of the cheapest’ market in which it and Saudi Arabia would emerge as the winners, and everyone else would be at risk.
In fact the Russian plan could be far more significant than a simple battle for market share, amid the whiff of a grand political game being played with the US oil industry, in particular the new crop of high-cost producers extracting oil from hard rocks such as shale, which are the ultimate target.
Attempts to crush the US shale oil business have been tried before by Saudi Arabia without success, with technological innovations offsetting the effects of surplus Saudi oil.
This time it’s Russia that wants to drive US shale oil out of business, possibly hurting the US economy in the lead-up to the presidential election in November.
It is a plan doomed to fail because while a sharp drop in the oil price might hurt high-cost US shale producers it will not hurt the US economy, which actually does better when oil prices are low (even if the oil industry is hurt).
The financial risk of an oil-supply glut is almost entirely a problem for countries that rely heavily on the commodity to balance their budgets, and that list does not include the US.
Helima Croft, head of global commodity strategy at investment bank RBC Capital Markets said OPEC and Russia were staring into the abyss.
“It’s not clear what Moscow gains by burning down the house,” she said.
Ms Croft is probably right when the situation is looked at as an economic issue, whereas when considered from a political perspective and the long-running hostility between Russia and the US, the situation becomes cloudy.
For WA, with its LNG-growth plans, the prospect of an oil-price war is a worry, because project development plans go back into the filing cabinet if the price does crash.
Nothing to cut
If daily shock-and-horror stories in the media about the coronavirus have dimmed your view of the big picture, the multiple factors influencing the economy and investor confidence, then find time to take a fresh look at the time bomb that is the cost of money: interest rates.
The great rates fall of the past few years has pleased homebuyers and propped up the property market at a time when everything else (except gold) is falling.
But as has been said countless times before, ultra-low rates are not a cure for anything if they persist, and a major problem when they shift into negative territory (the point when you pay the bank for the privilege of parking your spare cash in its vault).
Governments have responded to the outbreak of the coronavirus and the impact it is having on consumer spending by making further cuts in interest rates, to the point where they are probably doing more harm than good.
If retirees have not yet stopped spending they will soon, as will anyone else relying on investment income to meet living costs.
However, the real problem lurking in plain sight is the lure of high yields on some industrial and mining stocks, because those yields are dependent on future profits that might never arrive.
You don’t have to be a genius to see that the combination of a trade war, an economy-dampening virus, and the potential for Australia to slip into its first recession in decades is having a severe effect on business and investor confidence, which cannot be revived with more interest rate cuts.
The cutting game is over.
