Does the oil meltdown signal economic trouble ahead?

Crude oil's sudden meltdown could be nothing to worry about. Or it could be a sign that the world economy is...

Posted: Nov 15, 2018 12:37 PM
Updated: Nov 15, 2018 12:37 PM

Crude oil's sudden meltdown could be nothing to worry about. Or it could be a sign that the world economy is sick.

The abrupt bear market in oil prices may have been sparked by a sharp drop-off in demand for energy, which powers the economy.

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Investors were similarly spooked by oil's last major selloff, in late 2015 and early 2016. That dive to $26 a barrel led some to fear an imminent recession. That proved to be a false alarm.

"There are shades of this that remind me of the latter part of 2015," Citigroup CEO Michael Corbat said on Wednesday.

"The question today is: Is oil again pretending to be that canary in the coal mine around slower global growth?" Corbat said while speaking at the Economic Club of New York. "Because if you look at supply-demand figures, nothing at all has materially changed in the last week or two."

Supply shock

Analysts are divided over how much the oil selling is being driven by simple supply worries rather than a more alarming drop in demand.

It's clear that supply fears deserve at least some of the blame. Saudi Arabia and the United States are pumping record amounts of oil. US output alone is expected to spike by 2.1 million barrels per day in 2018.

All of that left the oil market brimming when US sanctions on Iran had a more muted impact than expected. Rather than carrying out its threat to zero out Iranian oil shipments, the Trump administration granted temporary waivers to China, India and six other countries.

Global growth slowdown

But demand is also playing a role.

The International Energy Agency said on Wednesday that while US demand for oil has been "very robust," demand in Europe and developed Asian countries "continues to be relatively weak." The IEA also warned of a "slowdown" in demand in developing nations such as India, Brazil and Argentina caused by high oil prices, weak currencies and deteriorating economic activity.

"The outlook for the global economy has deteriorated," the IEA wrote.

Indeed, data published on Wednesday show that the economies of both Germany and Japan outright contracted in the third quarter. It's the first time that the Germany, the economic powerhouse of Europe, is shrinking since the third quarter of 2015.

Last month, the International Monetary Fund downgraded its 2019 GDP estimates for both China and the United States due to the trade war. The IMF expects global growth to slow to 2.5% in 2019 from 2.9% this year.

Demand mostly to blame?

All of this helps explain why Ziad Daoud, chief Middle East economist at Bloomberg Economics, estimates that weaker demand was responsible for 85% of the decline in Brent crude since the October 3 high. The rest was caused by the supply shock.

"The lower oil price is reflective of reduced expectations for global energy demand," Daoud wrote in a report on Wednesday.

But the good news is that Daoud doesn't believe the oil market knows something the rest of the world doesn't. It's simply playing catch-up.

"We're seeing the symptom of slower global GDP growth, not a new shock to the world," he wrote.

Ed Yardeni, president of investment advisory Yardeni Research, agrees that crude oil does not appear to be a canary in the coal mine.

"I'm not particularly worried," Yardeni said. "I don't think the price of oil is telling me that we have a sudden weakening in the global economy."

Yardeni noted that while S&P 500 profits and corporate spending got dinged by the oil rout three years ago, the economic expansion managed to continue.

"It was a calamity for anyone in the commodity business, but not for the global economy," Yardeni said.

Nicholas Colas, co-founder of DataTrek Research, said that he won't get overly concerned unless crude collapses much further.

"If it gets below $45, markets will pay much more attention," Colas said.

Good news for drivers

The oil selloff thus far will cut both ways for the United States because the nation is both the largest consumer and producer of oil.

Recall that the 2014-2016 oil plunge sparked dozens of bankruptcies and hundreds of thousands of layoffs in the oil patch. Major energy-producing states like Texas, North Dakota and Oklahoma suffered. And oil investors got hit hard.

Yet American drivers will welcome cheaper prices at the pump, especially right before the holiday shopping season. After creeping up on $3 a gallon, the national average price of gasoline has declined 22 cents over the past month to $2.68, according to AAA.

"Consumers in America are in good shape," Yardeni said, "and having a plunge in the price of gasoline is a great Christmas present for them."

--CNN's Julia Horowitz contributed to this report.

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