The coronavirus epidemic in China has triggered restrictions in the country’s public transport and air travel, both at domestic and international levels, reducing demand for oil, which has lost about a fifth of its value since the start of the year.
The decline in the growth of 0.9 Million bpd is attributed to lower demand in China and 0.2 million bpd to the rest of the world. Overall, according to Rystad Energy, Chinese demand is expected to drop in 1Q20 by 0.3 million bpd y/y, instead of growing by a previously projected 0.6 million bpd. This will be the first quarterly y/y drop in seven years.
Similarly, the rest of the world’s demand, excluding China, which had been projected to grow by 0.6 million bpd in 1Q, is now expected to grow by only 0.4 million bpd.
According to the IEA, global oil demand will suffer its first quarterly drop in a decade as the COVID-19 virus lashes the economy in China and its impact ripples throughout the world.
“Global oil demand has been hit hard by the novel coronavirus (COVID-19) and the widespread shutdown of China's economy,” the International Energy Agency said in its latest monthly report.
While the IEA still expects demand for oil to grow for this year as the outbreak is contained, it slashed its forecast for the increase in global consumption by nearly a third to 825,000 barrels per day, the smallest increase since 2011.
The new coronavirus outbreak spurred China to take drastic measures such as placing in quarantine over a dozen cities and extending the Lunar New Year holidays in order to try to stem its spread, nearly shutting down key parts of its economy.
Although markets have rebounded in recent days as investors grew confident that China could quickly contain the virus and its economic impact would be short lived, the IEA warned against complacency by comparing today's crisis to the 2003 SARS outbreak. Viruses – like hurricanes, economic crises and armed conflicts – are ad hoc events that can significantly impair oil demand. The SARS virus, which originated in China around the same time of the year back in 2003, is believed to have eliminated all of the growth of global jet fuel demand for that year, which had been forecast at about 200,000 bpd.
China’s oil demand has now more than doubled since 2003. The country accounts for 14% of global air passengers carried and around 13% of global trade in goods, which is why the impact of a similar virus outbreak as SARS will likely be even greater now. Moreover, the death toll from the coronavirus reported has already surpassed that of SARS in 2003, and there’s a risk that the coronavirus impact may be understated.
‘Stronger global impact’
“While steps taken in China to reduce its spread were adopted earlier than in the SARS crisis and have been far more extensive, the profound transformation of the world economy since 2003 means China's slowdown today is bound to have a stronger global impact,” the IEA said in the report.
The IEA chopped its forecast for China's GDP growth in the first quarter of this year by 1.5 percentage points to 4.5 percent. It also made large cuts of over 0.5 percentage points to its forecasts for China's trading partners in the region, as well as the United States and Russia.
Oversupply concerns
With China being a big consumer of oil and the source of most of the growth in oil demand in recent years, the crisis will have a major impact on oil producers.
At the end of last year, OPEC and its allies including Russia, called OPEC+, agreed to further cuts in oil production in order to compensate OPEC+ for rising production in the United States and avoid excess supplies that would depress prices.
They are now considering an additional cut of 600,000 barrels per day to compensate for the drop in demand due to COVID-19.
The IEA estimates that the demand for OPEC crude has dropped from 29.4 million barrels per day (mbd) in the final quarter of 2019 to 27.2 mbd in the first three months of this year.
It noted that this is 1.7 mbd below what OPEC produced in January when the new production cuts came into force.
Gulf economies threatened by coronavirus
China, which absorbs one-fifth of the oil production of the six Gulf nations (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates), has reduced the pace of its refineries and seen its demand for and imports of oil fall in the face of the de facto containment imposed on Chinese cities of several million inhabitants.
Trade in non-oil products between Beijing and the Gulf Cooperation Council (GCC) has exploded in 20 years from a few billion dollars to nearly 200 billion dollars. China has also invested massively in the Gulf countries and their sovereign wealth funds have returned the favor.
More than 1.6 million Chinese tourists visited the Gulf in 2018, with the majority going to Dubai, which hopes to exceed one million by 2020. But as most flights from China have been suspended, the city-state's targets could be revised downwards.
Clouded perspectives
In the Gulf, which depends on black gold for more than 70% of its revenues, the impact of the epidemic will only add to the poor outlook if reforms are not undertaken to accelerate economic diversification. Oil revenues can enable CGG countries to invest in other sectors.
The IMF has published a report warning the GCC that its financial wealth (over $2 trillion) could be depleted within 15 years.
The fall in oil prices in 2014 had already strained the finances of the GCC countries, forcing them to borrow and draw on their assets to cover their persistent budget deficits.
Leading producers are now facing “two simultaneous setbacks,” according to Ellen Wald, author of “Saudi Inc.”.
“These (price) cuts, in a context of reduced output, could lead to economic shocks which, if sustained, could lead to political and regional instability,” she says in a commentary for Bloomberg.
“Fears surrounding the epidemic (...) have clouded the short-term outlook for the Gulf,” a Capital Economics report says.
“Lower prices and increased cutbacks in production will cause growth to move forward against a headwind in early 2020,” it added.
“Political consequences”
In response to the spread of the virus, the OPEC Joint Technical Committee (JTC) – which brings together the 13 members of the Organization of Petroleum Exporting Countries and 10 other oil-producing powers, including Russia – recommended a further reduction in production of 600,000 barrels per day.
Since the end of 2016, these countries have been bound by an agreement to limit their production in order to support crude oil prices in the face of abundant supply.
According to Ellen Wald, the difference between the current drop in prices and the previous ones is that it is linked to a factor beyond the control of oil producers, who were pumping at the time to the maximum of their capacities.
If the fears surrounding the coronavirus are confirmed, “Saudi Arabia, Russia and the Emirates will face low production and low prices at the same time,” explains the historian.
“If the situation persists, economic instability could have political consequences.”
US oil market vs coronavirus
On Friday 21st, Brent crude was down 1.4%, at $58.46 a barrel, while U.S. crude dropped 0.9%, at $53.38 a barrel after falling slightly below $50.
Both benchmarks were on track for their second consecutive weekly rise, with Brent up 1.8% and U.S. crude rising 2.3%, as fears over the virus' impact on demand eased earlier in the week and after a smaller-than-expected U.S. crude stock build.
For producers in places like Iraq and Saudi Arabia, that kind of price drop can mean a 10 percent loss in profits. But in the United States, where the break-even price for the average oil well drilled in shale fields is far higher at roughly $45 a barrel, some producers could lose as much as 60 percent of their profits, according to Michael Lynch, president of Strategic Energy and Economic Research.
“The big question is whether the Saudis will put oil in storage and wait to ride this out; and if not, everyone is going to see less money coming in,” said Mr. Lynch, who has advised OPEC in the past. “For the big guys like Exxon Mobil and Chevron, it's not a big deal. But for the small guys, they are going to be hurting, and you could see the number of bankruptcies rise sharply in the next few weeks.”
Forty-two oil and gas companies filed for bankruptcy protection in North America last year; since oil prices plummeted in 2015, there have been 208 bankruptcy filings by producers, involving roughly $122 billion in aggregate debt, according to the Haynes and Boone law firm.
“It's safe to say that uncertainty (surrounding coronavirus) has returned with a vengeance,” said Ole Hansen, head of commodity strategy, Saxo Bank.
“We have to acknowledge that we're dealing with the biggest demand shock since the financial crisis... Until we see China getting back to work, the virus will be the main focus.”
At a time when they are already cutting jobs and weighed down by debt, American oil producers are bracing for the latest shock to hit world energy markets: the economic effects of the coronavirus outbreak on China and beyond. American oil companies had already tightened their budgets last year, with roughly 14,000 of 750,000 employees in the United States losing their jobs. Over the last week, Exxon Mobil, ConocoPhillips and Chevron reported disappointing earnings because of low oil and gas prices and narrow profit margins.
The Chinese virus is spreading as oil producers are preparing their 2020 exploration and production budgets, which they will announce over the next two months. When the year began, oil prices had stabilized between $60 and $65 a barrel after cuts in OPEC production targets. But with prices now roughly $10 lower, executives predict that the industry will have to adjust.
“People are going to have to drop rigs and scale back production growth,” said Scott D. Sheffield, chief executive of Pioneer Natural Resources, a major Texas shale oil producer. “The question is, how fast the Chinese can stop the virus from spreading and start picking up oil demand.”
Mr. Sheffield predicted that if oil prices did not go up soon, domestic shale oil production, recently expected to increase by 500,000 to 700,000 barrels a day this year, instead would be flat.
