Two Black Swans? Sauve Qui Peut!


Black Swan one is Coronavirus, the Mummy of public health scares. OK the global infection rate is much smaller than flu and the mortality rate seems to be holding below 3% on the raw data and lower on the epidemiologists’ death-o-meter. But the evidence of massive, international disruption lies before us. I don’t need to recount the position nation by nation. There has not been a collective international response to this crisis after years in which international organisations have lost funding and credibility as the “rules-based global order” has given ground to go-it-alone nationalists and populists. In sauve-qui-peut Brexit Britain, Coronavirus survivors with bidets will form the new ruling class.

Black Swan two was already with us but our attention had wandered. Crown Prince MBS has reacted with characteristic stoicism and restraint to the breakdown of the Russia-Opec oil production cap. By opening the spigots and crying sauve-qui-peut in the oil markets he has caused chaos in global stock markets, bond markets, commodity markets, and foreign exchange markets. Shipping markets will surely follow.

On day one of this scenario it is not possible to foresee when it will end but we can indicate some consequences. There was already weak oil demand expected in 2020 due to the evident global economic slow-down. Coronavirus has deepened and lengthened the weak demand period. Now that supply side management has been ditched, we can expect lower oil prices for longer. That means big problems for highly-leveraged energy companies and big problems for their creditors. In a number of cases those creditors are already making contingency plans for the losses their airline customers will soon be announcing. The US Federal Reserve’s emergency interest rate cut last week may have to be repeated. Already interest rates on US bonds are hovering at multi-year lows and they could end up going negative. But if the Fed cuts rates and equities still fall, then investors will surely have raised the white flag as they liquidate profitable positions to cover their losses in banks, energy and transport stocks, luxury goods and FMCG.

There will be significant political consequences. Russia has lost its main partner in Opec and any chance it had of fostering goodwill among Opec members; it is already a Saudi adversary by dint of its position in Syria, which aligns it with Iran. Now Russia will be blamed by other Opec members for provoking MBS into this impetuous act. In the US Mr Trump owned the stock market peaks and will have to own the bear market in an election year. After four years of undermine the State Department, he has very little diplomatic capital to spend on persuading Russia and Saudi Arabia to resume their agreement, even though he will be desperate for them to help US shale producers who will be among the first casualties. As the US dollar weakens, so will the Chinese yuan, making it harder for the Chinese, already reeling from Coronavirus, to adhere to their trade agreement obligations to buy more energy and commodities with the US even as commodity prices fall. Japan, already in recession, will have to act hard to weaken its currency which has strengthened from 112 to 102 under three weeks. The government will come in for further scrutiny and criticism.

There will be ongoing commercial consequences. For instance, Japan’s shipyards will struggle for export orders if the yen stays strong. Any company that sells in USD but pays most of its costs in local currency could, if not hedged, finds its profitability expectations are undermined. That includes Brazilian farmers, Korean shipbuilders, Asian manufacturers and European banks.

THE TAKE AWAY

Normally lower oil prices would be good news for oil importers and oil consumers. That means China, as the world’s biggest oil importer, plus the EU and Japan as a sizeable importer-consumers. As Coronavirus stamps on oil demand, albeit for a short time without structural destruction to oil demand, the immediate effect of the Saudi move will be on cashflow and credit, already tightening due to weak demand. Central bank liquidity support will be vital until the energy markets settle down. Spare a thought too for ship owners who have invested in scrubbers; what will happen to the vital margin between 3.5% Sulphur and 0.5% Sulphur fuel oil? As gasoil prices slump, the economics of scrubbing evaporate. One is left thinking, what’s coming next? Whatever it is, we are already in a sauve-qui-peut situation in which survival is the main strategic goal: be long on cash and handwash.


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