Monday, March 9, 2020: A date that will go down in the history books for energy.
Consider these milestones:
- Crude oil futures plummeted 24 percent today. It was their biggest drop since the U.S. invaded Iraq in January 1991.
- The front month contracts expiring on March 20 (CLJ20) also had the most volume in at least a decade, surpassing 1.5 million.
- The SPDR Energy ETF (XLE), which tracks companies in the sector, had its biggest drop since being launched in 1999.
The selloff came after Saudi Arabia and Russia failed to keep their production cuts in place. Those two countries, never the best of friends, had supported oil prices by keeping supply off the market. Now instead of an alliance, they’ve begun a price war that will keep the globe awash in cheap energy.
But if that was the spark for the selloff, coronavirus was the dry tinder. Italy imposed travel restrictions on its northern industrial heartland over the weekend. There could be more cases of the disease as testing widens in other major economies like the U.S., France and Germany.
The result will be less driving and fewer flights. That, in turn, will have other consequences.
Junk Bonds on Edge
While cheaper oil has traditionally been a positive for the U.S. economy, this time might be different.
Junk bonds are one reason. Did you know that energy is the largest sector in the high-yield bond market? Lower oil prices now threaten to push countless smaller domestic fracking companies toward bankruptcy.
That, in turn, will make it harder for other companies to borrow. Combined with a general business slowdown because of coronavirus, firms across the U.S. may soon find it much harder to borrow.
Another potential problem is that the shale revolution has given a boost to the U.S. industrial sector. That’s likely to dry up now, which in turn may result in less investment, job losses and less spending.
In conclusion, oil was already under pressure because of a supply glut and coronavirus. But it went from bad to worse over the weekend. Don’t be surprised if the current drop now has wider ripple effects throughout the market and economy.