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Are Oil Markets Overreacting to the Spread of Coronavirus?
(Note: companies that
could be impacted by the content of this article are listed at the base of the
story [desktop version]. This article uses third-party references to provide a
bullish, bearish, and balanced point of view; sources are listed after the
Balanced section.)
The spread of the coronavirus continues to accelerate with China’s Health Commission reporting 361 deaths in mainland China which now surpasses the 249-death count associated with the SARS virus. Globally, the coronavirus has resulted in more than 800 deaths and has affected more than 17,000 people. The virus is spreading to other nations and is now affecting industries beyond travel, vacation and health. The energy industry has been hit especially hard with oil prices crashing. West Texas Intermediate (WTI) oil prices began 2020 on a high note peaking above $63 per barrel on January 2nd. Since then, the price of oil has fallen 20% to a price near $50 per barrel. Is the market overreacting to the impact of the virus or are market concerns warranted?
On the Bright Side
The drop in oil price is fear related, not demand
related. Some analysts believe the drop in oil price is overblown. Manish Raj, chief financial officer at Velandera Energy, for example, says that there is “no doubt that the actual oil-demand reduction resulting from the coronavirus will be temporary at best.” Jay Park, chief executive officer at ReconAfrica, says there is “no visible impact to demand just yet” and believes the price movement is being driven by fear.
Oil prices are tracking the SARS outbreak, but this time
is different. Oil price declined 20% during the SARS outbreak in 2003, a similar drop to that of the coronavirus. However, Bandana Hari, founder and CEO of energy markets consultancy Vanda Insights, points out that the biggest reason for the decline in oil prices in 2003 was not SARS, but the U.S. invasion of Iraq. Absent further issues in the Middle East, one could conclude that the impact on oil prices should not be a severe as in 2003.
A supply response may be coming. OPEC responded to the drop in oil prices by scheduling an emergency meeting on February 4-5 to discuss a cut in production. Analysts believe OPEC could cut as much as one million barrels per day of production. This would have a significant impact on a market that produces 80 million barrels per day.
Governments are taking steps to contain the virus. Nations are responding by limiting flights to and from China and quarantining new arrivals. The United States, which has reported 11 cases of the virus, allows only a handful of airports to accept flights from China. Other countries are following suit. Should the virus be largely contained to China, the impact on oil demand could prove to be less than originally feared.
Cause for Concern
China is the world’s largest oil importer. China consumes approximately 20% of the 80 million barrels of oil consumed daily. Chinese oil demand has dropped 3 million barrels of oil a day, or 20% of its total consumption in response to the coronavirus according to several sources within the Chinese energy industry. According to Bloomberg, the impact is probably the largest demand shock the oil market has suffered since the financial crisis of 2008-09 and the most sudden since the attacks of September 11, 2001.
The virus is beginning to affect the entire China
economy. The BBC reports that China’s central bank is prepared to pump 1.2 trillion yuan ($168 billion) into its economy. One state media outlet estimates that the virus could reduce China’s already fragile economic growth rate by two percentage points, which would equate to $62 billion in lost growth. Such a shock to China’s economy will undoubtedly have a significant impact on the country’s demand well beyond the virus’s containment.
Suppliers are less able to counter the drop in demand
than in the past. OPEC has responded to past declines in oil prices by cutting supply and is attempting to do so again. Unlike the past, however, OPEC’s influence on oil prices has decreased by the growth of the U.S. oil market. OPEC currently produces approximately 40% of the world’s oil production. Consequently, its ability to support oil prices by lowering production is questionable.
Big Picture
Whether the oil markets are overreacting to the spread of the coronavirus remains to be seen. Analysts who say the markets are reacting to fears of the virus getting worse are probably right. On the other hand, analysts who point out the importance of China as a consumer of oil are also right. The actual impact on oil demand is small at this point but has the potential to grow exponentially, just like the virus. And, if it does, there will be little producers can do to offset the drop in demand.
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Sources
https://www.cnbc.com/2020/02/03/oil-falls-to-a-more-than-1-year-low-below-50-on-fears-the-coronavirus-will-slow-global-growth.html, Pippa Stevens, CNBC, February 3, 2020
https://www.cnbc.com/2020/01/28/ceo-coronavirus-impact-on-oil-prices-not-entirely-comparable-to-sars.html?recirc=taboolainternal, Abigail Ng, CNBC, January 28, 2020
https://www.cnn.com/2020/01/31/economy/china-economy-coronavirus/index.html, Laura He, CNN Business, January 31, 2020
https://www.bbc.com/news/business-51347497, BBC, February 2, 2020
https://www.ncbi.nlm.nih.gov/books/NBK92473/, Jong-Wha Lee and Warwick J. McKibbin, “Learning from SARS: Preparing for the Next Disease Outbreak, 2004
https://www.barrons.com/articles/oil-prices-slump-on-fears-the-worst-of-coronavirus-is-yet-to-come-51580468401, Myra P. Saefong, January 31, 2020
https://www.bloomberg.com/news/articles/2020-02-02/china-oil-demand-is-said-to-have-plunged-20-on-virus-lockdown, Alfred Cang, Javier Blas and Sharon Cho, Bloomberg, February 2, 2020