Decision Day. Crunch time. Moment of truth. Call it what you will, the oil market is at a critical junction. OPEC and its non-OPEC allies will meet today to finalise a supply response to the mounting coronavirus crisis. This follows yesterday’s gathering of the 13-member OPEC in which it acknowledged the adverse impact of the Covid-19 outbreak. Accordingly, it came to a swift consensus that the oil cartel together with its non-OPEC partners should deepen existing production cuts of 2.1 mbpd by another 1.5 mbpd until the end of 2020.
That just leaves one – albeit big – hurdle to overcome, namely Russia. The new proposal is conditional on Russian support. Moscow has a history of dragging its feet on oil cuts commitment and has signalled its reluctance to jump on board with deeper curbs. It failed to endorse a previous OPEC+ recommendation to cut output by 600,000 bpd so the new figure may be too big a pill to swallow. That said, past protests against more cuts usually gave way to an eleventh-hour agreement.
Nevertheless, this time there are worrying hints that it may jump ship. Russia’s President Putin recently signalled he was content with oil prices at the current level. Meanwhile, the country’s finance minister said it was preparing for a possible drop in prices should Russia refuse to join the new cuts. Even so, it is hard to imagine Russia not eventually toeing the OPEC line. A failure to reach an agreement would send oil prices crashing into the abyss. In any case, the stage is set for contentious negotiations at today’s OPEC/non-OPEC meeting.
For its part, the OPEC leadership put on a brave face and claimed there was no reason to doubt Russian commitment to the oil partnership. Yet the prospect of a meaningful supply response from OPEC+ was overshadowed by the continued disruption caused by the coronavirus. The economic hit to the global economy and oil demand is looking more severe by the day. Little surprise, then, that risk assets were a sea of red yesterday. Brent lost $1.14/bbl to settle at $49.99/bbl while WTI ended 88 cts/bbl lower at $45.90/bbl. Shares on Wall Street followed suit with major indices dropping more than 3%. It will take a brave man to bet against further downside as market players succumb to virus anxieties.
When life gets worse before it gets better
Over the past month, forecasters have slashed their oil price estimates quicker than you can say “pass the hand sanitizer”. Standard Chartered cut its 2020 Brent price forecast to $64/bbl from $70/bbl. Bank of America trimmed its equivalent projection by $8/bbl to $54/bbl. Goldman Sachs downgraded its forecast on two occasions, first to $60/bbl from $63/bbl and then to $53/bbl. All the while, the deteriorating price outlook has been mirrored in the futures complex. Taking the year-to-date ICE Brent average and the remainder of the 2020 futures strip gives us an average forecast for this year of $52.17/bbl.
There are no prizes for guessing the catalyst behind this bout of axe-swinging. Oil prices have been riding the pain train since mid-January as a result of the coronavirus outbreak. The spread of the disease has crimped oil demand and nowhere more than in China. At its peak, fuel demand in China, where the outbreak originated, dropped by around 3 mpbd or 20%. Mercifully, the number of new cases in China is levelling off and economic activity is slowly normalising. However, the virus-induced downturn in oil demand is now gathering pace elsewhere as it spreads globally. Several other Asian countries are now battling the coronavirus. Serious outbreaks have also struck the Middle East and Europe. Most recently, the virus has reached America’s shores and prompted California to declare a state of emergency.
In short, Covid-19 is in the midst of an international offensive and the worst effects are yet to be felt. Global oil demand destruction is therefore poised to intensify. Accordingly, global oil demand growth prospects for this year are, in a word, gloomy. At best, world oil demand growth will be anaemic in 2020. At worst, global oil demand will decline annually for the first time since 2009. Those that subscribe to the latter view include Goldman Sachs an energy consultancy FGE. They expect world oil consumption will contract by 150,000 bpd and 220,000 bpd this year, respectively. Either way, the steep pullback in consumption has led to a significant build in global oil stocks and the supply surplus is likely to persist throughout 1H20. Suffice to say, this is not conducive for an imminent rebound of upward pricing pressures.
All the while, adding fuel to the bearish fire is the fact that the supply side of the oil equation is also displaying a negative bias. Aside from the near-complete removal of Libyan oil, which incidentally has largely gone unnoticed, non-OPEC supply growth is shifting up a gear. Producers outside of the oil cartel are boosting output with increasing vigour just as demand takes a dive. The IEA forecasts non-OPEC supply growth will reach 2.1 mbpd this year with gains led by the US, Norway and Brazil.
Faced with this double whammy of tumbling oil demand and surging non-OPEC supply, the onus now falls on OPEC+ to shore up prices. The producer group is poised to rubber-stamp extra supply curbs later today in a bid to mitigate the coronavirus-induced downturn in demand. Yet these extra cuts will fall short of eliminating the prevailing supply imbalance. Consequently, the oil market will struggle to shake off its malaise in the first half of this year. Only fresh signs of a rebound in demand can restore confidence in the oil balance. Until then, price support will be in short supply.
Looking ahead, the bullish bandwagon is confident of a gradual price recovering in the second half of the year. This, however, is by no means guaranteed. The loss in oil demand caused by the coronavirus remains unknown in both scale and duration and could surprise to the upside. What is clear is that it will take a long time to clear the excess built up in the first half of 2020. In the meantime, a fresh dose of price angst in on the cards as the peak of the Covid-19 pandemic still proves elusive.