Less than two weeks ago Donald Trump boasted of record-breaking highs on US stock indices. Not anymore. Financial markets were gripped last week by a fear factor as concerns over the escalating coronavirus outbreak reached fever pitch. The epidemic in China appears to have peaked but the rest of the world has seen a sharp increase in infections. Global cases are now approaching 90,000 across more than 50 countries on four continents. The increasing international footprint of the disease has fuelled fears of a pandemic.
Consequently, hopes for a short-lived coronavirus downturn have been shattered. The global economy is poised to face mounting downward pressures and is at increasing risk of a recession. Economic costs are already becoming evident. China’s manufacturing and services sector suffered the steepest decline in activity on record in February. Little wonder, then, that the IMF has said it will likely downgrade its world growth forecast.
Set against this gloomy backdrop, $5 trillion was wiped off world stocks last week. Shares on Wall Street were among the worst performers. The Dow Jones and S&P 500 plunged into correction territory after suffering double-digit weekly percentage losses in what was their worst showing since 2008. Oil wasn’t spared from the selling frenzy. The two leading crude benchmarks endured their steepest weekly decline in over four years. Brent briefly fell below $50/bbl before ending the week $8.62/bbl lower at $50.52/bbl. WTI lost $7.98/bbl over the period to settle at $44.76/bbl.
Faced with this sea of red, market players will look to central banks for support. As if cue, the Federal Reserve signalled on Friday its readiness to cut interest rates in response to the evolving coronavirus crisis. Japan’s central bank also pledged to cushion its economy against the widening Covid-19 epidemic. As for oil, all eyes will be on OPEC+ to stem the price rout. The producer alliance expressed confidence that it will respond responsibly to the spread of the coronavirus. In other words, it believes that it has what it takes to support the oil market. Yet as we argue below, it may be suffering from illusions of grandeur.
It’s decision time for OPEC and its non-OPEC allies. The producer group will meet in a few days to decide whether to cut output to mitigate the slump in oil demand caused by the coronavirus. Never could it have imagined that the gathering would come at such a tumultuous time for the global oil market. The severe disruptions caused by the expanding coronavirus epidemic has caused oil prices to tumble by 30% from last month’s high.
The Covid-19 virus was first reported last December in China. Infections across the country have reached 80,000 and are still swelling by the day, albeit at a slower pace. To little surprise, China’s economic growth has been significantly depressed as authorities imposed harsh quarantine measures to contain the outbreak. Moreover, this downturn in economic activity has severely curtailed the country’s thirst for the black stuff. China is the engine of global oil consumption growth, accounting for nearly one-third of the total increase. Recent forecasts of Chinese oil demand have been revised down between 1 and 3 mbpd — a reduction of nearly 20%. Needless to say, this spells bad news for the global oil balance.
The slump in China’s energy demand has given even the most ardent oil bulls a serious case of the heebie-jeebies. Yet there is more reason to fret. That is because the virus-induced pullback in oil demand is not limited to China. Indeed, the oil demand outlook beyond China has taken a hit as the coronavirus outbreak takes on a global dimension. Other energy-hungry nations in Asia including South Korea and Japan are now battling the disease. This will inevitably knock their oil consumption. Furthermore, a significant number of cases have struck the Middle East and Europe. This will depress oil demand in these regions, especially for air travel. All the while, the world’s biggest oil consumer, the US, is bracing for the epidemic to reach its shores. Put simply, a previous script of global oil demand growth rebounding this year has been torn to shreds.
Such is the rapidly evolving nature of the coronavirus epidemic that it is impossible to accurately gauge the full extent of the destruction in oil demand. But that hasn’t stopped some from trying. Forecasters have rushed to slash their global oil demand growth projections in the wake of the virus outbreak. Goldman Sachs now expects world oil demand to increase by 600,000 bpd this year compared to a previous estimate of 1.2 mbpd. Yet some see this downgrade as too conservative. The Institute of International Finance puts the same figure at between 300,000 to 400,000 bpd. Others, meanwhile, have taken a more draconian approach and warn consumption growth in 2020 will be practically non-existent.
Set against these feeble demand estimates, OPEC+ will have its work cut out to deliver a supportive supply side response. As things stand, the proposed cut of 600,000 bpd looks woefully inadequate. The pullback in Chinese oil demand alone is considerably higher than this figure. And let us not forget that the oil market was already facing a 1 mbpd surplus in 1H20 even before virus wreaked havoc on demand side of the oil equation. In short, an additional cut of 600,000 bpd would be akin to stick a small Band-Aid on a gaping wound.
The fact is that the extent of the demand shock requires a far more aggressive supply response from OPEC. Sensing this blatant reality, several key OPEC members were reportedly leaning towards a steeper cut of 1 mbpd. Yet such a sizeable reduction will likely encounter stiff resistance from Russia. In any case, whether OPEC+ deepens cuts by 600,000 bpd or 1 mbpd, it will still prove too little, too late. Additional supply curbs will fall short of balancing the oil market and will therefore fail to meaningfully shore-up oil prices. Only when evidence emerges that the coronavirus outbreak is under control will the current bout of price weakness abate. Until then, it will be a case of lower for longer.