Saudi Arabia's Gambit Sets Off Turmoil Across Financial Markets
DAVID GREENE, HOST:
Oil prices collapsed overnight after Saudi Arabia turned the market on its head. The kingdom had been trying to push crude prices up. But then in a startling move, Saudi Arabia completely reversed itself and started pushing prices down. This move is so shocking it has set off turmoil across the financial markets.
And I want to begin our coverage of this with NPR energy and transportation reporter Camila Domonoske. Good morning, Camila.
CAMILA DOMONOSKE, BYLINE: Good morning.
GREENE: So explain exactly what Saudi Arabia did here because, I mean, it's causing shockwaves around the world right now.
DOMONOSKE: Yeah. So two things - first, the Saudi oil companies started selling oil at a discount, undercutting the market price. And secondly, the kingdom is poised to massively ramp up production and flood the market with cheap crude. Taken together, those things sent crude prices plunging - their biggest drop in nearly three decades. And that prompted a lot of chaos and, frankly, panic in financial markets.
GREENE: So why - if this is now causing panic and having a lot of ramifications, why'd the Saudis do this?
DOMONOSKE: So to back up here, it starts with the coronavirus. So if you think about all the things that are done to slow the spread of a pandemic - people stay home, cancel trips; you call off big events; businesses go on pause for a little while - all of these things reduce the demand for fuel - right? - and that pushes prices down. So for weeks, Saudi Arabia has been trying to get prices back up by getting an agreement between world producers to cut production, to reduce supply. This is what OPEC exists for, right? It's a cartel of producers that try to stabilize prices exactly in situations like this.
GREENE: To coordinate, yeah.
DOMONOSKE: Yeah. But they're no longer powerful enough - the countries that are in OPEC - to move the market single handedly. I mean, the U.S. is now the world's biggest producer of oil, and we don't play ball with OPEC. So they need help. And specifically, they need help from Russia. But this time, Russia said no. Russia would not cooperate with cuts. And after talks with Russia failed, Saudi Arabia reversed course completely and said, fine, if we can't keep prices up because Russia won't cooperate with us, then we will push prices as low as we possibly can.
GREENE: Doing this at a time when the global economy is already really volatile and oil plays such an important role - so what do we expect the implications of all this to be?
DOMONOSKE: So huge questions here about what Saudi Arabia does and what Russia does - Saudi Arabia is placing a bet that they're going to be able to outlast their competition here. They can make crude very cheaply. They have a ton of it. And meanwhile, on the other side of the equation, Russia thinks that they'll be able to come out on top in this price war. Meanwhile, producers are definitely going to be hurt. This kind of a price war hurts everybody, including the main players who are involved.
But in addition to looking at what's happening with the suppliers, you also have to keep an eye on demand. I mean, this was all triggered by the coronavirus depressing demand for crude oil. Right? I spoke with analyst Ellen Wald, who said that that means there's an obstacle here if people like Saudi Arabia are trying to claim market share in this environment.
ELLEN WALD: Now they're cutting prices; they're going to increase production. But it's not clear they're going to have buyers for that oil.
DOMONOSKE: If you're flooding the market but nobody wants to buy it, you might not win as much as you expect.
GREENE: NPR's Camila Domonoske. Camila, thanks so much.
DOMONOSKE: Mmm hmm.
GREENE: I want to bring in another voice here. It's Mohamed El-Erian. He's the chief economic adviser at the European insurance firm Allianz and also the author of "When Markets Collide." Thanks for being here this morning.
MOHAMED EL-ERIAN: Thank you.
GREENE: So I think normally when we think about oil prices going down, we think that means cheaper gas at the pumps and that's a good thing. This is not necessarily a good thing, it seems.
EL-ERIAN: Well, it is a good thing for most consumers because gas will be cheaper and they'll have more money to spend on other things. But it's coming at a time when the situation in markets was already fragile. So think of yet another anchor being removed - and this in the face of a massive tide that comes from coronavirus disruptions. So it's yet another anchor that has been removed from markets.
GREENE: So if another anchor is removed and markets are going to become more volatile because of this, how bad could this get? And how are we going to feel the effect of it?
EL-ERIAN: Initial conditions matter, and we're coming from a situation where asset prices were decoupled in a big way from the underlying economic and corporate situation. So if you remember, last year, we had concerns about geopolitics. We had concerns about global growth. And yet, the S&P returned 30%. And yet, you made money on your risk-free asset. That's not supposed to happen. And yet, all this happened with no volatility. So we're coming from a fairly artificial conditions, and I'm afraid the reset is going to be a little bit volatile and unsettling.
GREENE: You've written about - and this phrase caught my attention - what you call the economics of fear playing a big role here. What exactly do you mean by that?
EL-ERIAN: It means that when you and I are taken out of our comfort zone, we tend to do two things - get paralyzed and get more risk averse. So we hear...
GREENE: And coronavirus has us out of our comfort zone, obviously.
EL-ERIAN: Yes, absolutely. We don't know what it is. We don't know how it's spread. But we're worried. And even though the numbers are very, very low and the probability of catching it is low and the probability of surviving it is very high, we are very risk averse, which means we don't go to the theater. We don't go out, so we amplify what's called an economic sudden stop. And in the process, we do two things - we destroy supply, and we destroy demand. This is very unusual. You see it in fragile and failed states. You hardly ever see it in modern-based economies such as ours.
GREENE: So if these numbers are where they are now, even if, I mean, this does not become catastrophic but it - the numbers keep going up at fairly alarming rates, the economics of fear could play a huge role. And I mean, the economic implications here could be serious.
EL-ERIAN: It could, but you could also reverse it rather quickly. And...
EL-ERIAN: ...You'll need two things for an economic bottoming-out. You will need, first, confidence, through medical advances, that we understand how the illness is spread and we can reduce our exposure and secondly, confidence - hopefully, through a vaccine - that we can increase immunity. If that happens, the underpinning of the U.S. economy is strong. And don't forget interest rates are very low, which means mortgage rates are going to be very low. Oil prices are very low. I worry less about the U.S. than I do about Europe. There, the existing fragilities were huge.
GREENE: I see. But if, you're saying, there are things that make us feel more confident about the outcome, that might protect us against a lot of economic repercussions in the short term. There's so much more to talk about here, and I'm sure we will be. But thank you so much for helping us understand this this morning.
EL-ERIAN: My pleasure.
GREENE: That was Mohamed El-Erian. He's the chief economic adviser at Allianz. Transcript provided by NPR, Copyright NPR.