By:Paa Kwasi Anamua Sakyi, IES
Oil prices have taken a significant hit following the rapid spread of the novel coronavirus that was first discovered in China. The epidemic according to The New York Times has killed over 800 people so far, and the figure keeps rising though at a reduced rate. China’s National Health Commission reports on February 9th that the number of confirmed infections rose to 37,198.
Fears over the coronavirus had already triggered a sharp fall in Chinese shares when the market re-opened after the Lunar New Year holiday. The Shanghai Composite index closed nearly 8 percent lower, its biggest daily drop for more than four years. Manufacturing, materials, and consumer goods companies were among the hardest hit, while healthcare shares soared. The fall came despite China’s central bank announcing new measures to ease the impact of the outbreak.
According to Lipow Oil Associates, both Brent and West Texas Intermediate (WTI) crudes have suffered losses amid the coronavirus outbreak, and things could still get worse. Analysts believe there could be another US$5 per barrel downside in this because it is difficult to tell the extent of the virus and how long it is going to last.
WTI traded at US$49.81 per barrel last Wednesday, down more than 18 percent since the beginning of 2020. Following a similar pattern, Brent traded at around US$54.22 per barrel, having fallen nearly 17 percent over the same period. Bloomberg’s report suggest that Brent posted its largest monthly loss since May 2019, as fears of the epidemic continue to rise. Records are that the 17 percent price decline recorded is also the worst January performance since 1991.
At 07:24 GMT on Monday February 10th the WTI benchmark was trading down US$0.06 (-0.119%) at US$50.11—more than US$3 down compared to last two week’s levels. The price of a Brent barrel was also trading down on Monday morning, by US$0.05 (0.092%), at US$54.42—off more than US$5 per barrel compared to last 14-days prices. Overall, the benchmarks have slid more than US$10 since the beginning of the year.
China’s oil demand amid the coronavirus outbreak is likely inflicting the worst oil demand shock to markets since the financial crisis of 2008-2009, with Chinese crude consumption slumping by 20 percent (the equivalent of the UK and Italy’s oil needs combined) since the beginning of the outbreak, and compared to the typical demand for the season, according to Bloomberg’s estimation.
China remains the world’s second largest economy and a key engine of global economic growth. As a result, any negative impact in China is almost certain to ripple across the world. Depressed oil demand in especially China remains the key contributing factor to the huge fall in Crude prices since the beginning of the year. And the fall in demand is contributing to a rise in crude oil stock around the world. The American Petroleum Institute (API) estimated on last Tuesday a larger than anticipated crude oil inventory build of 4.18 million barrels for the week ending January 31, compared to analyst expectations of a 2.8 million barrels build in inventory.
Fall in Business Activity
The sharp drop in oil demand is a clear manifestation of a decline in business activity in China, and a sign that the country’s economic growth which was already at a three decade low, will slow further.
The Lunar New Year holiday has been extended in much of China with major cities in full or partial lockdown. Offices and shops remain shut, and cinemas were forced to close to try to contain the virus. Meanwhile, numerous factories have suspended production while companies have instructed employees to work from home. Foxconn, Toyota, Starbucks, McDonald’s and Volkswagen are reported as just a few of the corporate giants to have paused operations or shuttered outlets across China.
Bloomberg reports that, in an effort to contain the novel coronavirus, the Chinese authorities have also suspended air, road, and rail travel in the area around Wuhan and placed restrictions on travel and other activities throughout the country.
That means the world’s biggest importer of crude oil, which usually consumes about 14 million barrels a day, needs a lot less oil to power machinery, fuel vehicles, and keep the lights on.
The outbreak have had a particularly large impact on demand for refined products, especially jet fuel, as major airlines around the world suspend flights to China, and travel restrictions within the country mean far fewer flights. Australia, Singapore, Germany, Japan, the Great Britain, and the United States are among the countries that have imposed travel restrictions, urging citizens to reconsider their needs to travel to China.
Citigroup Analysts have estimated that global oil demand could drop by 1 million barrels per day as a result of the virus. The prediction by Bloomberg is that China’s crude oil demand had slumped by 20 percent, the equivalent of the UK and Italy’s oil needs combined.
In response that the coronavirus is having a toll on fuel demand, Reuters reports that Asia’s largest oil refiner Sinopec, which is owned by the Chinese government, has cut the amount of crude it is processing by about 600,000 barrels per day, or 12 percent; its biggest cut in more than a decade. Also China’s independent refiners in Shandong Province have cut refinery processing by as much as 30 to 50 percent in just over a week, operating at less than half of their refining capacity due to the sharp fall in local consumption, coupled with the fact that they are not allowed to export fuels, unlike the state-held corporations.
Bloomberg reports that the depressed crude oil demand have left commodity trading houses and oil majors scrambling to find spot buyers for crude oil outside China in the face of rising fuel stocks on the oil market.
According to Poten & Partners, “the main differences between 2003 SARS outbreak and 2020 Coronavirus are the size of the Asian economies and their regional energy demand.” China in particular, has experienced dramatic growth in the intervening period, moving its daily oil demand of 5.8 million barrels per day in 2003 to close to 13.6 million barrels per day in 2019. And so any impact on Chinese/Asian oil demand is likely to be much more significant, not only in terms of volume but also in terms of oil import flows and the ripple effect on tanker markets, according to the energy consultancy and brokerage firm.
Expectations from OPEC+
The general expectation is that, the Organization for Petroleum Exporting Countries (OPEC) and non-OPEC producers, sometimes referred to as OPEC+ could extend production cuts to support falling oil prices, as the intensifying outbreak of the coronavirus hampers oil demand growth.
In a research note published last Tuesday, Bjarne Schieldrop chief commodities analyst at SEB, said that “tactical cuts are OPEC’s strongest card.” He believed the group and its partners will most likely step in and reduce supply for a month or two in order to prevent an inventory build-up which the market would have to struggle with for an extended period. HFI Research is also of the view that, no one has a clear picture of just how much demand dropped, but if OPEC were to respond, it should respond decisively and overcut the potential demand.
But it is also becoming increasingly clear that even though OPEC cut back, try to balance output and stabilize prices, they have less influence on the oil market, hence the need to maintain on board the non-OPEC producers like Russia to deliver their ultimate goals.
OPEC member Iran was among the first few to publicly call for measures to support oil prices as the coronavirus hit demand. The statement came following leaks that OPEC+ will discuss output cuts of between 500,000 and one million barrels a day at a meeting that was scheduled to take place last week.
OPEC President Mohamed Arkab who had previously indicated that the virus outbreak will have little impact on the global oil market in the near-term, had also suggested the Middle East-dominated producer group is ready to act to any further developments. Saudi Arabia’s Energy Minister Prince Abdulaziz bin Salman has also insisted that OPEC+ has the capability to steady the oil market if necessary.
However, others remain doubtful of any meaningful effect of OPEC+ cut back, as there exist the possibility of the group to lose market share, and that gap could be filled by non-OPEC+ producers.
John Driscoll, chief strategist at JTD Energy Securities supports this position, arguing that because the balance of power has shifted, with the introduction of “massive new fields” in Norway, Brazil and Guyana, and of course, the U.S. being the biggest non-OPEC producer, OPEC+ cuts wouldn’t have any significant impact.
Meanwhile, there are indications that the much-touted emergency meeting of OPEC+ ministers sometime this week, probably won’t happen after all. Azerbaijan Energy Minister Parviz Shahbazov has recently noted that Ministers from the group and its allies are unlikely to hold an early meeting this month, while one planned for March will go ahead. Again, Russia has been resisting Saudi Arabian efforts to reduce output after OPEC+ technical experts recommended an additional cut of 600,000 barrels a day through June.
Stephen Innes, Asia Pacific market strategist at AxiCorp, has said in a note that should OPEC fail to reach an agreement to cut supply, there could be additional downside to prices. He believes a drop in U.S. drilling activity will be required to make a sufficient dent in global oil supplies.
Written by Paa Kwasi Anamua Sakyi, Institute for Energy Security (IES) ©2019
Email: [email protected]
The writer has over 23 years of experience in the technical and management areas of Oil and Gas Management, Banking and Finance, and Mechanical Engineering; working in both the Gold Mining and Oil sector. He is currently working as an Oil Trader, Consultant, and Policy Analyst in the global energy sector. He serves as a resource to many global energy research firms, including Argus Media and CNBC Africa.
