All economists, including myself, predict the spread of Covid-19 will put a big brake on economic growth through reductions in spending, particularly on travel. Assuming the virus outbreak lasts for about six months, the lower spending will likely last until the fourth quarter. Countries like Thailand, which depend heavily on foreign tourist revenue, will be hurt the most.
That's why Kasikorn Research Centre has just clipped its Thai GDP growth projection for 2020 to a mere 0.5%. Shocking news to many, though not to me.
But wait. The Kasikorn Research Centre may soon have to revise that figure again — not in light of the Covid-19 outbreak but because of the oil industry crisis and the global debt crisis.
For the global oil industry to thrive, the oil price needs to be above US$50 per barrel on the West Texas intermediate (WTI) index. The industry will be hit by bankruptcies if the price drops below US$30 (942 baht) per barrel. This is particularly true for the US oil industry. A 2017 Federal Reserve Bank of Dallas survey identified a tipping point of $46 per barrel. Below this point, the cost of drilling new wells in the US exceeds the revenue from the oil, so new drilling stops. If the price drops below $30 per barrel, half of the existing oil wells in the US will shut down.
On Monday, the crude price slumped to $27.57 per barrel, putting the US oil industry on the brink of bankruptcy. The US oil industry is the largest in the world with 18% of global output, but it also carries an extremely large debt burden. This amounts to an estimated $240 billion of oil-related debt, all set to mature by 2023. Defaults on this magnitude would trigger a collapse of the US financial system similar to what we witnessed in 2008. Now you see why Wall Street is in a serious panic.
The Covid-19 outbreak plus the oil supply and debt crises are certainly more than the world economy can handle. The threat of global recession is imminent and it may even lead to a worldwide depression. No government in the world wants to see that happen.
Oil producers know well that Covid-19 outbreak is softening global demand for oil. This will push down the price. When the oil price plunged to $30 a barrel in 2016, Opec asked Russia to form the Opec+ group and cut world output by 2.1 million barrels per day. The measure was successful, since the oil price jumped above $40 per barrel within two months and stayed above $50 thereafter.
On Jan 3, the WTI crude price sat at a comfortable $63.05. Then, the Covid-19 outbreak changed everything. Oil prices began to tumble as the contagion spread. Seeking to repeat the success of Opec+, Saudi Arabia asked the group to cut output by an additional 1.5 million barrels per day. This time, however, Russia said no, and the world oil price took a nosedive. At the time of writing, the WTI crude spot is US$35.33 a barrel — a far cry from the safety level of $50.
Why is Russia doing this? Only the Russian government knows. But my guess is that the Russians might have considered that the oil price had dropped from a level of $60 per barrel at the beginning of the year to $50 early this month, in line with the impact of Covid-19. Moscow may have factored in a further fall to the $40-45 mark, secure in the knowledge that its production cost is only $17.20 a barrel.
However, the market has shattered those expectations in the past few days. The oil industry is vital to the Russian economy, accounting for 16% of GDP, 52% of tax income to the federal budget, and 70% of export income. Russia itself cannot afford to have the world oil price at its current level. So how will this oil price war end? I can make an educated guess.
The Covid-19 impact is already bad enough. Nobody — not the US, Saudi Arabia, Russia or the rest of the world — can afford to have that impact worsened by an oil war and debt crisis. But the end won't come easily, or without the Russians being taught certain lessons first. And, most importantly, the US oil industry still has time (until June) before it starts defaulting on its huge debts.
Let’s stay on the energy issue before I focus back on the impacts of Covid-19. Even if the oil price somehow jumps back to the $45-50 level, the US shale oil and clean energy industries would still be dead as the barrel-equivalent cost of producing shale oil is around $50 and clean energy around $70. Readers may want to think twice before betting their bottom dollars on clean energy and related industries like electric cars. The issue of “economics vs environment” is about to revisit all governments again.
There is universal agreement that the Covid-19 outbreak is devastating to all economies. To counter its impacts, all governments are rolling out economic stimulus packages. Unfortunately, no government has the powerful economic tools available when they were combating the sub-prime debt crisis of 2008. Back then, the US Federal Reserve Board cut its interest rate by 5% and pumped $1 trillion into the system to shore up the economy. By early this year, the Fed fund rate was down to 1.5%; even cutting the rate to 0% would not help the economy much compared to 2008. With Fed policy likely to be ineffective, President Trump has been forced to offer a payroll tax cut. Other major central banks are in the same boat as the US Fed. The European Central Bank borrowing rate is currently at zero while the Bank of Japan base rate is minus-0.1%. What more is there to be cut? Monetary policy is worthless as a means of shoring up economies hit by Covid-19 at this point.
I will have more to say on the ineffectiveness of government policies amid the Covid-19 outbreak in my next article. Read my comments on the lame duck Thai government and its central bank next week.