Global markets suffered a steep drop over consecutive days this week, dragged down by fears related to the rapidly spreading coronavirus beyond the borders of China.
Oil demand has fallen sharply in China, which, even if the pandemic had been brief, would have had global ramifications. Now, however, the effects of the coronavirus could be deeper and more long-lasting than previously thought. WTI sank below $50 and Brent was down to about $53 on Wednesday, the lowest level in more than a year.
As February comes to a close, the number of countries affected is increasing rapidly.
For several weeks, China shut down part of its economy in an effort to contain the coronavirus. But as February comes to a close, the number of countries affected is increasing rapidly. Large numbers of new cases are now confirmed in South Korea, Iran and Italy, among others, and there are signs that the virus is potentially spreading across much of Europe and maybe even the Middle East. On Wednesday, Brazil confirmed its first case of the virus, the first such incident in Latin America. The World Health Organization said on Tuesday that, for the first time, more cases were confirmed outside of China than inside.
The U.S. Centers for Disease Control and Prevention ratcheted up the warning on February 25. “It’s not so much of a question of if this will happen anymore but rather more of a question of exactly when this will happen,” Dr. Nancy Messonnier, director of the National Center for Immunization and Respiratory Diseases, said in a news briefing.
Oil demand had already declined sharply in China as tens of millions of people faced lockdown.
Oil demand had already declined sharply in China as tens of millions of people faced lockdown. The estimates from oil market analysts on the impact vary, and continue to change by the day. Oil prices declined substantially in recent days, but the broader plunge in financial markets illustrates the growing concern for the global economy.
“While these cases have increased concern as to the likely scale of the oil demand loss resulting from the coronavirus outbreak, we still think that trader and analyst consensus is underestimating H1 demand losses,” Standard Chartered warned in a note. “We expect a coronavirus-related demand reduction of 2.05 million barrels per day (mb/d) in Q1 and 1.91 mb/d in Q2 with more modest demand gains in H2 resulting from economic stimulus and the deferral of some H1 consumption.”
For its part, Goldman Sachs cut its global oil demand growth forecast to just 0.6 mb/d for this year, down from 1.2 mb/d previously. “If the coronavirus spreads further globally, then we expect further downside risk to our estimates,” the investment bank cautioned. Goldman lowered its forecasted average Brent price for 2020 to $60, down from $63 previously.
“The oil market is thus being pressured by several factors at once,” Commerzbank wrote in a note. “Prices are under pressure not only from the recently stronger US dollar, which generally follows the opposite direction to prices; the massively weaker physical demand is also weighing on prices, as is the ‘investor exodus’ that we are seeing now.”
What happens next?
OPEC+ meets on March 5 to weigh a possible production cut, which would come just a few months after it last slashed output. This time, however, Russia has hesitated, so the outcome is uncertain. Even if the coalition decides to cut deeper – the Joint Technical Committee recommended a reduction of 600,000 barrels per day (b/d) a few weeks ago – it is not clear that it will be enough to prevent a further slide in prices. As the CDC warns, the outbreak could spread to the U.S., which would not only cut into oil demand directly by curtailing travel, but could also slow the economy, a double-whammy for oil consumption.
The flip side of the downturn in oil prices is that financial pressure on U.S. shale drillers continues to rise.
The flip side of the downturn in oil prices is that financial pressure on U.S. shale drillers continues to rise. As the largest source of new supply growth in recent years, shale growth is set to grind to a halt. Schlumberger’s CEO Olivier Le Peuch told Reuters that U.S. shale supply growth could slow more or less on a permanent basis. “Next year it will be 200,000 barrels per day,” Le Peuch said, a substantial deceleration from the 600,000 to 700,000 b/d estimate for this year, which itself is down from 1 million barrels per day in 2019.
More importantly, he does not see the heady growth rates returning, instead output could plateau. “Shale production growth will go to a new normal…unless technology helps us crack the code,” he said.
Meanwhile, investment bank Raymond James warns that although oil prices will take a hit this year, prices will have to rise to avoid a supply shortfall in 2021. The decline in upstream spending over the past half-decade (relative to prior years) will start to translate into lower levels of supply growth. The investment bank forecasts Brent prices of $65 per barrel this year, but a big increase to $80 in 2021.
For now, with the coronavirus raging, that scenario seems hard to imagine. The narrative over the next weeks and months will likely be dominated by the extent of damage from the pandemic.