The coronavirus epidemic is a black swan that has severely disrupted the outlook for the global oil market, and at this moment it remains unclear how large the destruction in demand will be because of the outbreak.
Various estimates project that the coronavirus will shave 250,000 bpd to 500,000 bpd off global oil consumption this year. However, viruses can take uncertain turns, spreading wider and linger longer than initially thought.
Since the beginning of 2020, the deadly covid-2019 virus has ripped through the industrial heartland of the world’s second largest economy, disrupting supply chains, creating transportation bottlenecks and locking down over 150 million people. As the virus shows no signs of easing, health authorities across the world now warn of a credible risk the outbreak could evolve into a global pandemic, with grave consequences for global trade, energy demand and the world economy.
Meanwhile, Organization of the Petroleum Exporting Countries and its partners are scrambling to agree on a policy response to the expanding demand shock, slowed by Russian opposition to deeper output cuts. Not even a 20% decline in oil prices over the past four has convinced the Kremlin to act on a proposal from Saudi Arabia to aggressively cut production by a further 600,000 bpd. And oil prices could be set to fall further if OPEC+ refrains from taking action.
The Covid-19 virus is a true black swan that hit the global oil market at the worst time possible. After a year of simmering trade tensions, investors were counting on a rebound in global crude demand to balance the market against the backdrop of new supply from countries like Guyana, Brazil and Norway. In December, shale producers in the United States reached a fresh record high output of 13.1 million bpd, even as banks sharply reduced their lending to the industry.
Markets needed China—the engine of global consumption growth—to buy these barrels. Over the last year, China has become the world’s largest importer of crude oil at around 11 million bpd and has accounted for nearly one-third of global consumption growth. Recent forecasts of Chinese oil demand have been revised down between one and three million bpd—a reduction of nearly 20%. Global oil demand is now nowhere near where it’s needed in order to balance the market this year because of the magnitude of this decline.
So far, covid-2019 has proved particularly devastating for China’s central province of Hubei located in the country’s industrial heartland, forcing thousands of factories to close their doors and creating severe shortages of materials. According to the Centre for Research on Energy and Clean Air, China’s nitrogen dioxide emissions fell 36% in the week after the Lunar New Year, which translates to a 25% to 30% reduction in activity across industrial sectors such as oil refining, coal-fired power generation and steel production.
Assuming factories operate at full capacity by April, Bloomberg Economics has downgraded China’s first quarter growth estimates to a multidecade low of 5.4%. Surprisingly, OPEC reduced its forecast for China’s oil demand by only 200,000 bpd during the current quarter, even as their projections for economic growth fall in line with Bloomberg estimates.
I argue that the outbreak of coronavirus could damage the Chinese and global economy enough to lead to a more prolonged period of lower demand and low oil prices, respectively. Beijing has been injecting billions of dollars into its financial system over the past few weeks to shield its economy against the virus-induced slowdown. However, a sudden economic disruption cannot be fixed by easy money or interest rate cuts. Furthermore, imposed quarantines vary greatly from province to province and are not expected to be lifted simultaneously, leading to prolonged transportation bottlenecks across China even after new cases peak.
A significant adverse economic impact due to the raging coronavirus is simply unavoidable and it will not stop in China. Last week, Japan reported the sharpest deterioration in its industrial activity in over seven years, driven by a slump in export orders from China and South Korea.
Outside of Asia, Germany has also seen its export orders to China drop as a result of lower demand for their machinery. Today’s China is more integrated into the global economy than ever before. Any progress or deterioration in the efforts to contain the viral outbreak in its industrial heartland will disproportionally affect markets globally. Until investors start seeing signals that the coronavirus has been contained, the markets will continue to sour, and the struggle could continue during the first half of 2020 if not longer.
Oil markets are no exception here, as Russia continues to block OPEC’s efforts to support prices by making deeper cuts, and Moscow is expected to do the same at the group’s next meeting on March 6th in Vienna. Russian oil companies have voiced strong opposition to lower output as they have struggled to comply with the existing quota.
Moscow needs oil prices to be at around $40 per barrel to balance its budget, so Russian oil minister Alexander Novak is not terribly alarmed at the current level of around $50. Its OPEC partner Saudi Arabia, however, needs oil closer to the $80 mark. Because of those differences and the pain of more cuts, OPEC+ has helplessly watched a slide in crude oil prices since early January. At this juncture, only an aggressive cut of 800,000 to 1 million bpd, even if a temporary measure through the second quarter, would be able to lift oil prices to a sustainably higher level.