Virus pummels oil and it will get worse as (or if) the virus does
Despite Libya taking so much oil supply off the market, sentiment about the virus is affecting prices even more
Launceton — A question for the crude oil market: Why is the potential loss of a few hundred thousand barrels per day (bpd) of demand due to the coronavirus in China more important than the actual loss of about 1-million bpd of supply from Libya?
Benchmark Brent crude futures have slumped about 10% since January 20, the last day prices rose before the current losing streak, with the contract ending at $59.32 a barrel on Monday, the weakest close in three months.
The hit to oil prices has come as the number of cases of the new coronavirus outbreak, centred on the Chinese city of Wuhan, has soared and the disease has spread to several other countries.
At least 106 people have died and more than 2,800 have been infected with the virus, and Chinese authorities have effectively locked down Wuhan, a city of some 10-million people, and several other cities.
The spread of the virus has pummeled the price of crude oil and, indeed, other commodities, as the market fears it will lead to a slump in fuel demand as people cancel travel plans and economic activities are curtailed.
It’s obviously hard to quantify what the exact hit to demand will be, with much depending on how quickly the virus is contained.
If the experience with severe acute respiratory syndrome (SARS), another type of coronavirus that struck Asia in 2003, is any guide, there will be a short, sharp hit to fuel demand, particularly jet fuel, followed by a recovery. Once SARS was contained, the overall hit to crude oil demand for the whole year was limited, suggesting that the market may be over-reacting to the current, admittedly concerning, headlines about the new coronavirus.
How much is Chinese crude oil demand likely to drop because of the virus? The answer may be surprisingly little, especially immediately.
Translating the estimated SARS demand impact into 2020 volumes points to a potential negative shock to global oil demand of 260,000 bpd on average, Goldman Sachs has estimated.
In any case, Chinese refiners will have largely locked in crude purchases for as far out as April and May and are unlikely to try to sell distressed cargoes, even if domestic demand for fuel weakens.
What’s more likely is that any surplus crude will find its way into commercial and strategic storage, especially if the current price slump is maintained.
Of course, if the new virus continues to spread and authorities struggle to deal with rising infection rates, then all bets are off. But while dramatic media headlines help to drive sentiment-driven price swings, it’s interesting to note that the physical crude oil market has tightened considerably in recent weeks.
Civil conflict in Libya has knocked almost 1-million bpd of output offline, with the North African country’s state oil firm saying it was down to 262,000 bpd from 1.2-million previously.
Nigeria’s exports are also under a bit of a cloud, with major producer Royal Dutch Shell declaring force majeure on shipments of the Bonny Light grade on January 22 after a pipeline was shut.
Kazakhstan suspended oil shipments to China on January 16 after the discovery of excess levels of organic chloride, although some crude has since started flowing from the central Asian country.
The point is that the actual loss of supply to the world crude market from Libya and Nigeria is far higher than the potential loss from the new coronavirus.
However, such is the sentiment-driven nature of trading in futures that it’s possible oil prices will continue to struggle as long as the media headlines paint a picture of a virus spreading, infecting more people and threatening economic growth across China and the rest of Asia.
However, assuming the virus is contained at some point in the next few weeks, the market may turn its attention to the physical supply-demand balance, which may not be quite as bearish as currently feared.