The World Health Organization now describes the coronavirus as pandemic. It warns that more countries will join Iran and Italy that are already in the frontline of the disease. The announcement triggered a chain of events that sent investors in the financial and commodity markets looking for shelter. The new label will neither accelerate nor slow down the spread of the virus but the response to it will. President Trump suspended all travel from the 26 Schengen countries and the UK will now focus on delaying the spread of the virus instead of trying to contain it.
The glimmer of hope, namely that new confirmed cases seem to be plateauing and even falling in China and South Korea is currently irrelevant. What matters from the economic perspective is that the world is paralyzed as it is going through unprecedent times in modern history. After the BoE followed the Fed in cutting interest rates, we had the second confirmation that monetary stimulus is much weaker than the virus itself. The FTSE-100 index lost 1.4% yesterday. In the aftermath of the WHO decision other stock markets followed suit. The MSCI Global Equity Index was down 3.6% on the day and the S&P 500 Index lost nearly 5%. Asian equities are falling this morning. Without intending to sound a doom-monger the situation is dire both socially and economically. The peak is still weeks, if not months, away and the aftershock will be felt through 2020 if not beyond.
Concerns and fears about the economy pressure oil prices. Only that this time the energy market is additionally having to deal with bearish supply side developments, too that come in the form of a price or market share war between Saudi Arabia and Russia. Considering this powerful bearish cocktail that eventually should send oil prices back below $30/bbl the market did well yesterday by only shedding around $1.40/bbl.
This relatively modest fall was due to the weekly EIA statistics and within that distillate stock movements. Although crude oil inventories built 7.7 million bbls, much more than the forecast, product stocks experienced significant draws. Gasoline stocks were down 5 million bbls and distillate stocks saw an outflow of 6.4 million bbls. Consequently, total commercial stocks fell 7.6 million bbls on the week. Demand destruction has not hit US shores just yet (refiners supplied a healthy 21.9 mbpd of products last week) but the worst is yet to come. As the virus is spreading in the US the economy will gradually slow and stock builds are anticipated in the not so distant future.
The gravity of the virus outbreak is not only reflected in outright price movements but also in spreads. The front-month Brent spread lost 57 cents/bbl!! yesterday and settled $1.44/bbl in contango. It is the widest discount for five years. The current Brent structure is a gold mine for those who are in the position to store oil now and sell it later. For the rest of the world, however, it is all gloom.
Thirst for oil disappears
Supply-demand estimates are similar to the futures curve. At any given moment they reflect the true belief of market players but as even unfolds they change. The latest set of data from the IEA/OPEC/EIA is an excellent example of this. The coronavirus has a profound negative impact on all walks of life and oil is no exception. After the IEA released its downbeat forecast on Monday both OPEC and the EIA followed suit yesterday. We usually concentrate on OPEC call estimates as the most indicative measurement of the health of the oil market, this time, however, it would not make much sense to do so. This is because OPEC has put Ecuador in the non-OPEC category whilst the other two still count it as the member of OPEC. As a result, we would compare apple with pear regarding the demand for OPEC oil.
Anyway, the common theme is demand revision. This year global oil demand growth now stands to be a mere 100,000 bpd on average. When you consider that this figure was 1.25 mbpd back in December the impact of the coronavirus is obvious. Although only the IEA sees demand contraction from 2019 the EIA cut its growth estimate from 1.43 bpd to 360,000 bpd (it is rather optimistic under the circumstances), whilst OPEC revised it down by 1.08 mbpd to 50,000 bpd.
Of course, the first half of this year looks dreadful because the effect of the epidemic is expected to dissipate in 3-4 months’ time – fingers crossed. In December 1H 2020 demand was projected to be 100.53 mbpd. It is now 98.51 mbpd. This is a demand destruction of over 2 mbpd in three months. Now wonder that the OPEC+ group technical committee recommended a reduction of 1.5 mbpd last week. And no wonder that prices are falling towards the $30/bbl level as it was refused by Russia and Saudi Arabia consequently threatens to open the oil spigot.
It is only the EIA that provides us with an insight of futures OECD inventories. It is almost certain that these estimates will change in months to come but the current forecast makes for a dreadful reading. The agency foresees OECD oil inventories to build up to 3,035 million bbls in 2Q and peak at 3,060 million bbls in the July-September period. As a reminder, they finished 2019 at 2,902 million bbls when Brent averaged $62.42/bbl in the last quarter of the year. In the first half of 2016, when the market tried to recover from the Saudi-created supply shock, inventories in the developed part of the world rose to 3,054 million bbls with Brent falling below $30/bbl. If the current projection comes anywhere near reality it is hard to see the market recover until September-October. There is really not much more that could be said about the latest estimates. Demand destruction is obvious, OPEC+ action will be vital in the foreseeable future.