Will oil prices keep falling?

This is an audio transcript of the FT News Briefing podcast episode: Will oil prices keep falling?

Joanna Kao
Good morning from the Financial Times. Today is Monday, August 15th, and this is your FT News Briefing.

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Pakistan has depleted its foreign reserves and Saudi Arabia is stepping in to help. Oil prices have fallen a lot in the last several weeks. We’ll look at why and how long this could last. Plus, we’ll dig into what a major US spending bill could mean for share buybacks. I’m Joanna Kao, in for Marc Filippino, and here’s the news you need to start your day.

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Saudi Arabia has agreed to renew a $3bn deposit at Pakistan’s central bank, the FT has learned. This deposit will shore up Pakistan’s depleted foreign reserves. And it comes just as Islamabad is negotiating an aid package with the International Monetary Fund. Last month, the IMF agreed to increase its loans to Pakistan, but on the condition that Pakistan receive financial support from elsewhere.

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American and European drivers have been getting some relief at the pump. Lower gas prices have followed falling oil prices over the last couple of months. After Russia’s invasion of Ukraine, crude oil hit a high of $120 a barrel. Now it’s below $100. We asked the FT’s Derek Brower what’s behind this.

Derek Brower
It’s really about 3 R’s, I would say, recession, fierce recession. Recessions tend to kill oil demand growth. Russia, the notion that Russian production was going to collapse has not materialised. And then the third R is releases of oil from the US and other western countries’ strategic emergency stockpiles of oil to offset what they expected to be big drops in supply from Russia as sanctions tightened on Russia following its invasion of Ukraine. But actually what’s happened is Russia has managed to keep sending oil out at greater volumes than people expected. And yet all of this oil from the emergency stockpiles around the world has seeped into the market. So that’s driven prices down on the supply side.

Joanna Kao
We just saw Saudi Aramco post record profits for the last quarter, a reflection of high oil prices. Other oil majors also reported record profits. What do falling prices mean for oil companies?

Derek Brower
The next quarter won’t be as robust in terms of profits and dividends and so on as the one that’s just passed. But oil companies in general, Saudi Aramco, which reported yesterday, is a bit of an exception. But oil companies in general, especially ExxonMobil, Shell, BP, Total, they’re really price takers more than price makers. So they do very well when the oil price is going up, you know, for reasons that may or may not be connected to their own decisions and their strategy and so on. And they do very badly as they did during the pandemic, oil crash when prices fall. So to answer your question, the earnings for the oil majors in the next few months, they’re going to reflect pretty much directly what the oil price does. And as I say, there’s quite a lot of volatility expected in the market in the coming months.

Joanna Kao
What are you watching for in oil markets in the months ahead?

Derek Brower
So I think the oil market, they really focus on the two big consumers in the world, the US and China. The first question is whether the US is heading into recession. And then the second part of that is whether China is going to emerge from Covid lockdowns and consume oil with the same almost insatiable thirst that it had before the lockdowns took hold and dampen some of its demand. So those are the two really big moving parts. If the US goes into recession, that will hurt demand for oil and the biggest petroleum market in the world. If China emerges from the Covid lockdowns with a much healthier economy and more thirst for oil, that will lift demand from the second biggest petroleum market in the world.

Joanna Kao
Derek Brower is the FT’s US energy editor.

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In the US, President Joe Biden plans to sign a $700bn spending bill into law this week. The Inflation Reduction Act is aimed at the climate, healthcare and lowering the deficit. It also raises corporate taxes. Corporate America is not happy, of course. One big change is a new minimum corporate tax rate of 15 per cent. And there’s also a new 1 per cent tax on share buybacks. That’s when companies buy their shares back from investors, a gift to shareholders that tends to boost the price. The FT’s Ethan Wu explains why lawmakers included this.

Ethan Wu
This is an idea that gained a lot of momentum among Democrats in 2021. And the argument they’ll make here is that firms have, and the implication is somewhat selfishly, chosen to do stock buybacks to boost share prices at the expense of investing in workers and investing in equipment. That’s the argument they’ll make.

Joanna Kao
So how do corporations justify share buybacks? It’s pretty standard, actually. Can you remind us of the business rationale?

Ethan Wu
For companies, share buybacks are a really attractive way to return cash that they have to shareholders when they don’t have good investment opportunities to use that cash on. And, you know, the traditional way that you would return cash to shareholders is through dividends. But the issue with dividends is that they’re often more committal than share buybacks. Once you raise your dividend or start paying a dividend, it’s a little bit difficult to lower it again or to stop paying it. With stock buybacks, it’s more flexible. You can do one round of stock buybacks when you have the cash on hand. And because this tool is so flexible for companies, you’ve seen even someone like Warren Buffett who’s really like, you know, kind of a consummate long termist, in the height of the bull market in 2020 and 2021, start to issue share buybacks at Berkshire Hathaway just because it was such a useful tool for him to return money to shareholders.

Joanna Kao
How much of an impact will the tax actually have on corporate earnings?

Ethan Wu
I’ve been surprised by how not worried investors have been about these taxes. Which isn’t to say that they love them, which isn’t to say that they’re great, but they’re just rather small overall. And just to start with the impact on corporations, many big banks that have studied this are projecting a small hit to earnings. That hit will be the sharpest at companies that do a lot of buybacks and pay currently low corporate tax rates. So, you know, famously a lot of tech companies, but the magnitude of the earnings hit that we’re talking about here is really surprisingly small.

Joanna Kao
And why is that?

Ethan Wu
I think the biggest reason is that the tax rate, 1 per cent on net share repurchases, is really quite small overall. This is half of the 2 per cent rate that Senators Ron Wyden and Sherrod Brown had proposed last year. And it’s just not expected to raise that much money overall and to affect corporate behaviour all that much.

Joanna Kao
That’s FT financial reporter Ethan Wu.

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Before we go, Mexico’s president, Andrés Manuel López Obrador, wants to shake up his country’s beer industry. Most production happens in the north of the country, which is in a severe drought. President Obrador blasted beer makers for using water from dwindling aquifers. The industry has denied that. Last week, Obrador demanded a halt to brewing in the north. He wants production to shift south. Mexico is one of the world’s biggest beer exporters, thanks to the popularity of Corona, Modelo and other brands.

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You can read more on all of these stories at FT.com. This has been your daily FT News Briefing. Make sure you check back tomorrow for the latest business news.

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