The Price of Oil and the Stock Market

Another impactful development pushing the price of stocks down Monday morning was the recent surprise drop in oil prices.  Crude oil saw its price decline by 24% on Monday.  That is a massive move for the worlds most demanded commodity.  On balance, lower prices will be good for the global economy.  However, price shocks are interpreted by the stock market as uncertainty, further aggravating pricing pressure.

To understand why the price of oil dropped so far so fast we must look at the Saudi Arabia monarchy and what has been transpiring over the last few years.  You may recall the rise of Mohammad Bin Salman, one of the many sons of the current King Salman.  Back in June of 2017 in a surprise move, Mohammad Bin Salman was named Crown Prince, which made him next in line to succeed King Salman.  Crown Prince Mohammad Bin Salman is in his 30’s.  There are many older brothers and uncles that could be in line to succeed King Salman.  Therefore, Mohammad Bin Salman had to cement his position and did so by having many of his relatives arrested and held captive at the Ritz Carton hotel or under house arrest.  It was a power move and the Crown Prince has been conducting them ever since.

Shortly after Mohammad Bin Salman was named Crown Prince, he went on a world tour to attract business and investment to Saudi Arabia.  As well thought out as the plan might have been, it fell short.  These types of investment decisions take time.  While the Saudi family has been successful investors in real estate, technology and other asset classes, the Crown Prince wants to build a more diversified economy.

Another major move Crown Prince Mohammad Bin Salman made was liberalizing Saudi culture, specifically allowing women to drive and meet in public without the presence of their husbands.  It is clear Crown Prince Mohammad Bin Salman convinced the King of a bold new vision for the country.  Now it appears we have entered a new chapter.

Saudi Arabia is the worlds largest producer of crude oil.  It is believed they still have vast reserves.  As the leading oil producer, Saudi Arabia is a member in the Organization of Oil Producing Countries, OPEC.  Saudi Arabia has gone along with OPEC decisions over the years but it appears Crown Prince Mohammad Bin Salman is no longer interested in cooperating with the organization.  Here are a couple of reasons why that may be the case.

First, his economic and cultural plan is going to take some time to materialize; a near term a focus on their strategic asset may make sense.

Second, the regional conflicts in the area are largely funded by oil.  Iran and Russia are the other primary players with Syria, Yemen, Iraq and others the proxies.  It is thought that Crown Prince Mohammad Bin Salman is trying to crush Iraq and Russia oil production by pushing the price so low they are unable to make a profit.  Both Russia and Iran have very old oil infrastructure that needs investment, so a large reduction in the price of oil puts their already vulnerable economies in a difficult position.

Here in the U.S. we are now insulated from the global price of oil and do not have to concern ourselves with middle east politics the way we have in the past.  We are already a low-cost producer and net exporter. 

The big takeaway for investors is lower oil prices should turn out to be a big win for the global economy in the coming months and one of the components that will help drive an economic and stock market recovery.

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