Market Overview

5 February 2020

Oil Market Has Some Deeper Reasons to Fall Beyond the Coronavirus Influence

Among the variety of financial assets, oil is probably playing the role of the main victim of the Chinese coronavirus. As the Wall Street Nasdaq index jumps to a new all-time record and the S&P500, together with the Dow Jones index, posted their biggest one-day gains over the last six months on Tuesday after the People's Bank of China (PBoC) $242.74 bln liquidity injection, the oil futures continue to slide, not finding any solid ground.

With the stock markets clearly becoming more relaxed towards the coronavirus impact, the partial relief did not actually even touch the sentiment in Brent or WTI. A suggestion voiced by some experts before the drop in oil prices had much deeper origins than just a simple explanation that the terrible virus was the influencer, becomes more evident with every day.

Bloomberg "sources" in China pointed recently to a possible decrease of up to 20% (three million barrels of crude oil per day) of the demand from the world's biggest oil importing country at a moment. At the same time, British Petroleum's (BP) Chief Financial Officer Brian Gilvary's view is that demand is down on average for the year by 300,000 to 500,000 barrels a day only. If this suggestion turns out to be a reality,, it threatens to wipe out a third of the 1.2 mln bpd of global oil demand growth, which is what was expected by BP for the upcoming year before the deadly virus outbreak. But, even if this is the case, it would mean still a limited effect in comparison with the Bloomberg figures mentioned above.

However, there are more forecasts with a wide range of expected demand growth this year. The International Energy Agency's (IEA) group of experts had estimated at the end of 2019, before the virus outbreak overtook the market, a large surplus of about 1 million bpd in global oil output for 1Q2020, plus a possible 200,000 bpd decrease of world demand until the end of 2020. At the same time, the Organisation of the Petroleum Exporting Countries (OPEC) continues to announce a proposed 700,000 or even 1 million bpd growth in demand. Many market traders used the IEA outlook to put pressure on oil prices, since the very beginning of January as soon as the market crowd realised that oil prices would be able to soar again only under some new force majeure conditions in the Middle East region. Former buyers quickly lost all their faith in $70/bbl for Brent oil, and almost everybody stepped aside to open a path for the strong sellers. That helped the prices to come down quickly, below $65, and the coronavirus news just helped them to push the prices lower.

Brent oil futures broke through one-year low of $54/bbl and the WTI futures traded last night in the Asia market under $50/bbl. That is more than a 18% fall in oil prices since January 20, although the composite Bloomberg Commodity Spot Index dropped by just eight %. Going back to March 2003 when the SARS virus seized the market, the same average Commodity Spot Index went down as much as nine %. SARS had a bigger ratio of deaths to infected individuals by almost ten% at the initial stage of the disease expansion. Commodity markets had fully recovered the losses by the end of October, 2003. Wells Fargo experts released a note on Tuesday with oil price projections based on SARS modelling. Experts believe that commodity prices could be somewhere near their bottom.

The assumption of the close end of the downtrend, however, could be correct only if the coronavirus effect is considered. But, the large exporters from OPEC+ group are probably feeling the deeper nature of the present strong "big short" play, so they called an emergency meeting of the Joint Technical Committee (JTC) on February 4 to 5. According to Bloomberg sources, after quick monitoring and analysis, JTC could recommend to hold one more urgent meeting with OPEC+ ministers before February 15. The Committee suggestion to further cuts of at least 500,000 bpd by OPEC+ members, is to be considered. Russian energy minister Alexander Novak said Russia could take part in the meeting, but he did not give any clear guarantee that Russia would support any additional cuts. Russian President Vladimir Putin had a phone conversation with the Saudi king and prime minister Salman bin Abdulaziz Al Saud, they confirmed a readiness to further coordinate actions in the OPEC+ format to ensure the stability of the global oil market, but no specific arrangement were announced.

Wall Street Journal cited another "source" announcing even more radical unilateral cuts by Saudi Arabia by one million bpd, regardless of other OPEC+ countries' decisions. The takeaway of almost ten % of Saudi production could be considered as an intention to shock the market. The efficiency of any new attempts to reduce the oil production can raise doubts. Such urgent measures might demonstrate the inability of the OPEC members to provide proper demand forecasts. It would be a better decision for the OPEC leaders to make a "poker face" and just allow the price to go under $50 for Brent with the hope that the market may rebound and return the prices back to $60 or higher.

This might work taking into account that OPEC+ has already supported the market with a December 2019 agreement to cut the production by 1.7 million bpd. Also, Libya was forced to keep its production at the lowest levels due to civil conflict. Lower prices, below $50, would revive the risks for the American shale industry. According to Freedom Finance review, the number of US bankrupt companies in the oil and gas sector reached a peak of 208 companies over the last five years, while the total bad debt of the entire industry exceeded $120 billion.

Jeff Currie, Head of Commodities Research at Goldman Sachs looks at the whole process from a slightly different angle: "They (OPEC) cannot do much. Right now, the tankers are being loaded for April deliveries. By the time supplies are reduced, about 60 days would have passed, and the situation with the coronavirus may already be resolved."


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