From increasing numbers of COVID-19 cases in the United States, to an oil and gas price war between Saudi Arabia and Russia, the world economy has had quite a week.
Stats You Should Know:
- As of Thursday, the Center for Disease Control and Prevention (CDC) reported 1,215 cases of the novel coronavirus (COVID-19) in the U.S., and 36 deaths.
- CNN reported Thursday that U.S. crude oil dropped 6 percent to $31 a barrel after President Donald Trump announced the European travel restrictions. Crude dropped to as low as $30.02 a barrel, which was down 27 percent for the week.
The spreading coronavirus pandemic isn’t the only thing affecting the oil and gas prices, or the overall economy, including the pumps industry. This past Monday saw a historic collapse, CNN reported, after Saudi Arabia and Russia launched a price war. The tension rose after the alliance between Organization of Petroleum Exporting Countries (OPEC) and Russia imploded. The alliance started in 2017 when Russia began restraining its oil supply to support prices. Last Friday, Russia refused to agree to OPEC’s proposal to further cut production to help the oil market following the downturn related to the coronavirus.
In light of the undulating economic state, Pumps & Systems asked one of its marketplace experts, commercial banker Chris Angle, to weigh in on how the pumps industry may be affected and predictions for what’s to come.
Pumps & Systems: Tell us more about this Saudi-Russian price war—what’s at play here?
Angle: To start with, the Saudi/Russian price war is a function of their specific geopolitical maneuverings, rather than an underlying economic strategy. Ironically, both of these governments need higher oil prices in order to maintain the levels of government spending underlying the social contracts with their respective populations. At the same time, they both have current geopolitical interests that dictate low oil prices. In the case of Russia, they would like to drive prices down in order to try and damage U.S. oil companies and shale producers, and by extension drive down U.S oil/natural gas production. Hopefully, from their perspective, a reduction in U.S. output will enable Russia to obtain higher oil/natural gas prices down the road. This is a gamble, because it is an open question as to whether U.S. producers can hold out with lower oil prices longer than can Russia. If Russia doesn’t win this bet, then they are going to end up with oil prices below what they would like to have; specifically prices they have seen over the last couple of years.
In the case of Saudi Arabia, their geopolitical reason for pushing low oil prices is to destabilize their archrival, Iran. The Trump Administration and the Saudis have likely been hoping that the people in Iran will change the regime themselves. Putting economic pressure on the regime accelerates its loss of legitimacy with the population. Over the last few months, protests have erupted inside Iran, and indications are the regime has used deadly force against some of the protesters. Pushing oil prices down is likely to further destabilize a regime, which has itself been a source of instability in the Middle East for the better part of 40 years. Like the Russians, the Saudis are in a race against time in that they need their strategy to be effective before they absolutely have to have higher prices (some estimates put it at $80/barrel) to sustain their government spending commitments that underlie their social contract.
At some point, one side of this bet or the other is going to have to throw in the towel, at which point oil prices will rise. Although predicting where oil prices will end up is more of a guess than anything resembling true analysis, predicting prices to eventually settle somewhere between $50 and $70 barrel (which was where it was pre-crisis) seems reasonable. Although Russia can probably live with this, Saudi Arabia is going to have difficulty.
P&S: How does all of this oil and gas turmoil affect the pumps industry?
Angle: As for pump companies in the oil business, it appears that oil companies are shelving plans for capital expansion, which will have a substantial impact on those pump manufacturers with significant exposure to this industry. How long this drop in capital expenditures goes on depends on how long Saudi Arabia and Russia can keep up pressure on oil prices before somebody blinks and reduces production to elevate prices. Companies that have significant exposure to this business segment should strategically plan for a longer period of reduced customer demand than those whose only exposure is to companies facing a temporary setback caused by the coronavirus.
P&S: Speaking of the coronavirus, how do you see that affecting the U.S. economy—for the short term and the long term?
Angle: As for the effect of the coronavirus, the economic numbers are definitely going to be impacted. How much economic damage there is going to be is anyone’s guess. Supply chains in China appear to be back up and running, and the new coronavirus cases appear to have dropped off precipitously. One can expect that, at some point, Europe and the U.S. will see a similar reduction in new cases, and the panic will subside. The key is what the economy will look like going forward.
I suspect that the economic impact, while measurable (especially in the first quarter) will be substantially less than what the worst predictions are saying. What is effectively happening right now from an economic perspective in certain countries is that the entire country is going on vacation. This is not completely alien to Europe. August tends to be a month when some countries effectively shut down and everyone heads to the beach. Obviously in these cases, the lower productivity is accompanied by higher spending in the vacation/entertainment branch, which is not happening now. The point is that while economic numbers will take a hit relative to normal years, it is not likely be an economic collapse.
In the U.S., the thought of everyone taking a month off is an alien concept. And given the amount of unused vacation that Americans accrue every year, a forced vacation is likely to impact economic numbers more than what is maybe to be expected in Europe. However, the U.S. economy does tend to be more flexible than Europe and so I would expect a faster economic recovery.
P&S: What about certain branches of the economy, such as the service sector or smaller businesses?
Angle: There is also a question that pundits are talking about which is regarding some businesses ultimately going out of business and people losing their jobs. This is certainly a real fear. It should be remembered though that if the disease follows a pattern similar to what it appears to have followed in China, Europe and America should be through the worst of it in a month. Companies that are not able to weather a month of being shut down (if that is in fact what happens), are going to be those that were in a weak financial position to begin with. In other words, they are going to be those that would have been the first to go under the next time a recession hit. This economic pause is simply going to, in most cases, accelerate their demise. For more established, prudently managed companies, this pause will be painful but not fatal. In fact, some may come out of this in a stronger strategic position since their weaker rivals will have been removed as competitors.
P&S: So in the long term, what should we expect?
Angle: A month from now when Armageddon hasn’t happened, the economy will have a feeling of returning to normal. Economic numbers will show a downturn, and a technical recession is certainly possible, perhaps even likely. But given the extreme measures being taken, a recession will feel like a return to normal. And given that this slowdown will have a clear noneconomic/business cycle culprit (coronavirus plus government reaction), which will be in the past, I would expect that business expectations/demand going forward are going to be stable even if the coronavirus will have caused a temporary reduction. In short, American companies should dig in and weather out the storm, which will be shorter and less damaging than what today’s headlines are implying.