OPEC reported on Monday that Saudi Arabia cut its oil production in July, a surprise move after Riyadh had pledged to ramp up output following the June meeting in Vienna. Why, then, did oil prices fall on Monday?
The answer may lie in Turkey, where a political standoff with the Trump administration has led to a sudden currency crisis. It may not seem obvious at first, particularly since Turkey is an insignificant producer of oil and a rather minor consumer as well.
But it isn’t a sudden drop off in demand in Turkey that the market is concerned about, but rather the potential for economic and financial contagion stemming from the current crisis.
U.S. President Donald Trump announced last week that he planned on doubling the steel and aluminum tariffs on Turkey, a move that kicked the currency crisis into high gear. The lira is down 30 percent over the past week and 50 percent since the end of July.
The tariffs are overwhelming to the Turkish economy by themselves, but the levies come as emerging market currencies have already been under pressure this year. The U.S. Federal Reserve continues to hike interest rates, helping to strengthen the dollar at the expense of other currencies. Global growth is also showing some signs of strain. The currencies in Argentina, South Africa, Brazil, India and Indonesia have all been hit with bouts of turmoil recently. Related: Is This The Most Important Geopolitical Deal Of 2018?
“The problem is that the world is addicted to a super-low interest rate environment,” Richard Fullarton, founder of Matilda Capital Management Ltd., a commodity focused hedge fund, told Bloomberg. “The transition to higher rates will be more painful than expected. We should expect lower rates of growth during a transition phase.” Meanwhile, the ECB is concerned that European banks are too exposed to Turkey, another avenue that could cause some trouble.
Currency volatility is occurring against an economic backdrop that is also showing some cracks. The U.S.-China trade war have raised fears of a slowdown, a problem that the IMF warned about last month.
Copper, which is often cited as a key barometer for the health of global commodity markets and economic activity in general, has been slammed in 2018, even as analysts entered the year with bullish optimism. Reading too much into copper, which has its own unique set of circumstances, can be risky, but it offers one data point that suggests investors are jittery about the global economy. Another potential barometer to watch, air freight activity, also points to a slowdown.
The plunging Turkish lira is not by itself a threat, especially, as mentioned, Turkey is a minor player in the energy markets aside from acting as a transit country. “The direct impact on global demand for oil is thus negligible,” Commerzbank said in a note. However, “[i]f the crisis spread to other, larger (emerging) countries, though, demand would be hit considerably.” Related: Philippines Cracks Down On Fuel Pirates
Commerzbank said that the crisis in Turkey is “home-grown” and the result of “serious errors on the part of the political leadership,” which means that “there is actually little threat of other countries being dragged down as well.” The flip side of that is that with the U.S.-Turkey relationship on the rocks, Ankara will “almost certainly not comply with the U.S. demand that it buy less oil from Iran now.”
The only way this becomes a larger crisis is if Turkey’s problems ignite currency trouble elsewhere. China’s yuan dipped a little more than 0.3 percent on Monday, adding to the losses the currency has sustained this year.
Weaker currencies magnify the pain from higher oil prices. In local currencies, oil prices are now at or above the record price levels for oil seen back in 2008 in Turkey, South Africa, India and Indonesia. If Turkey’s crisis is the potential to set off a currency wildfire in emerging markets, it would make petroleum products prohibitively expensive for many people, potentially leading to a significant slowdown in global demand. The IEA warned that the oil market could see a “cooling off” later this year, noting that demand already slowed in the second and third quarters, substantially down from the first quarter.
It’s not at all clear that Turkey will be the spark that ignites a deeper selloff. But with the market increasingly jittery, the risks to oil from seemingly unrelated political events such as the one unfolding in Turkey can’t simply be dismissed.
By Nick Cunningham of Oilprice.com
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