Dr Brendan Rynne, Chief Economist responds to global and local market volatility

Despite the volatility on global and local markets, the COVID-19 pandemic is not like the GFC. It’s in fact very different and so are its effects. Notably COVID-19 presents a pandemic environment which in and of itself is transient and won’t be intractable.

The GFC on the other hand was different in that it was a systemic failure which revolved around a misallocation of investments (ie. housing) due to a mispricing of risk (ie. people were lent money who shouldn’t have been lent money at rates that were too low). The misallocation of investment began several years prior to the ‘start’ of the GFC in 2008, which is why it also took several years for the build-up of problems to unwind.

The COVID-19 situation has started off as a supply shock (ie. less workers producing less output), and is then likely to flow into a demand shock (ie. people buying less and buying different things to what they normally purchase).

And that brings us to this recent episode of share market volatility – the main problem as I understand it relates to the oil market. With lower world production due to the virus, oil demand will drop off, which will lower the price of oil (all else being equal). OPEC wanted to curb production so prices remained high, but Russia hasn’t agreed to this, so Saudi Arabia dropped its market price and the world oil price has since fallen by approximately 25% to approximately US$30 per barrel.

Saudi Arabia is the lowest cost oil producer in the world at approximately US$5-10 per barrel, and Russia is about US$20 per barrel, so they will still make a profit on oil sold at this low price. But US oil producers – mainly shale – have a marginal cost of production in excess of US$30 per barrel, so they will produce at a loss. And this loss in the US oil industry will place debt pressure on the sector, causing the market to think there will be some failures in the sector. Hence the sell-off on markets around the world.

Ultimately COVID-19 is a temporary issue, but how long it persists and how much disruption it causes are still unknowns. These unknowns do create uncertainty in the market, which can overreact as we have recently seen.

The upside for Australian consumers is the drop in the oil price will translate to a drop in prices at the petrol bowser and if people are spending less to fill up their cars, then they will have more cash to purchase other items which could be a positive for the economy.

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