Can Oil Keep Rallying After Last Week’s Plunge?

Is the worst over for the oil market? Last week, crude oil prices plummeted in tandem with the stock market on fears of the spreading coronavirus outbreak. After trading near $53 per barrel in mid-February, benchmark West Texas Intermediate dropped as low as $43 last week as virus cases multiplied around the world. Talk of travel bans, canceled conferences and consumers too scared to fly prompted traders to sell crude futures at seemingly any price. But WTI rebounded at the end of the week and has shot higher to start this week. It recently traded near $47 per barrel on hopes that OPEC and Russia will support prices by significantly cutting their production.

A big production cut would help balance the market. And the Federal Reserve’s decision today to cut its benchmark interest rate by half a percentage point could also buoy oil prices. Meanwhile, civil war in Libya is crimping that country’s exports, and energy companies are drilling fewer new wells in the U.S.

But despite all those developments, I think it’s too soon to sound the all-clear for the oil market. After talking with economists and commodities analysts in recent days, the impression I’ve gotten is that no one knows how much of an economic impact the coronavirus is going to have. China’s oil-guzzling economy has clearly taken a huge hit, but the damage outside of China is still an unknown. Cases are popping up in the U.S., but it’s not yet a full-blown epidemic.

Beyond the actual public health impact, we also don’t yet know how severe the public’s psychological reaction may be. Will workers stay home from their jobs if an outbreak occurs in their city? Will consumers shy away from malls and restaurants if they fear getting infected?

Maybe all of this will blow over soon. Maybe any coronavirus cases in the U.S. will end up no worse than the typical seasonal flu. Maybe consumers and companies will mostly go about their business as usual.

But you have to be a pretty staunch optimist to invest according to that scenario. Financial markets were clearly unprepared for the widening scale of the virus, which lead to last week’s dizzying drop when it became apparent that coronavirus would not be confined to China. Now, economists are cutting their forecasts for global economic growth this year. (My colleagues at The Kiplinger Letter think that global GDP growth could be cut in half and that a worst-case virus scenario could tip the U.S. economy into recession.) Weaker economic activity means weaker global demand for oil, and historically, OPEC has not always been able to agree on big oil output cuts to balance drops in demand.

One market forecaster I check in with regularly, Stephen Schork of the energy investing newsletter The Schork Report, mentioned $41 per barrel as a likely floor for oil prices if the coronavirus threat worsens. That would represent more than a 10% drop from where prices are right now.

I expect significant volatility to dominate the market in the coming days, with plenty of sharp moves up and down depending on the headlines of the day. It’s easy to imagine WTI rallying back to $50, or sinking close to $40.

For consumers, the upshot of all this turbulence will probably be cheaper gas prices, at least in the short term. The national average price of regular unleaded is down to $2.42 per gallon, according to travel website AAA. A week ago it was $2.47. Given that it it’ll take a few more days for last week’s plunge in oil prices to filter through to the retail level, I expect gas prices to dip at least a few more cents in coming days. Diesel prices are down too as global freight shipping suffers.

So wait a bit to fill up your gas tank if you can. And be cautious if you’re eyeing any oil-related stocks to buy.