Coronavirus: Impact on oil price, demand, and output

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The Coronavirus is not just making people ill, but is affecting financial markets as well. Stock markets worldwide are feeling the impact of the deadly virus that originated from Wuhan, China. Along with financial markets, this Coronavirus is also having an adverse effect on oil prices.

Coronavirus and oil prices: what’s the relationship?

According to a recent report from Goldman Sachs, the Brent oil prices have dropped by $11/bbl since the outbreak of the China virus. In fact, the cost of crude has dropped to its lowest in a year after dropping about 20% from the peak in January.

Understanding the impact of the coronavirus on oil prices is quite simple. China extended the Lunar New Year holiday along with putting travel restrictions to limit the spread of the virus. Because of this, factories, offices and shops remain closed. This eventually meant that China, which is the world’s biggest importer of crude oil, is consuming a lot less oil than it normally does (about 14 million barrels a day).

According to Bloomberg, China’s daily crude consumption has dropped by 20%. To give you some idea of how big this drop is, Bloomberg says it equals to the combined oil demand of the UK and Italy.

Owing to the drop in the oil demand, Sinopec, which is Asia’s largest oil refiner and is owned by the Chinese government, slashed crude processing by about 12% or 600,000 barrels per day, its biggest cut in over a decade.

Another impact of the coronavirus on oil prices is in the form of lower demand for jet fuel. Following the outbreak, almost every airline globally has suspended flights to and from China. Moreover, there are travel restrictions within China, resulting in fewer flights.

How big is the impact?

To analyze the impact of the coronavirus on oil prices and global oil demand, OPEC (Organization of the Petroleum Exporting Countries) and its allies met Tuesday in Vienna. OPEC is also in talks with China over how the coronavirus may hurt oil demand and what should be done to check falling oil prices.

Though it is certain that the coronavirus outbreak would impact oil prices, there are different views on how big the impact could be. OPEC’s own numbers (worst case scenario) suggest a drop of 400,000 barrels a day for about six months. BP Plc, however, estimates a bigger impact of a drop of about 300,000 to 500,000 barrels a day for 2020 as a whole. S&P Global Platts, on the other hand, expects the annual demand to take a hit of 320,000 barrels a day, the biggest since the 2008 to 2009 financial crisis.

Producers are evaluating further oil cuts, along with rescheduling the planned policy meeting from March to February. Only last month, OPEC started with fresh cutbacks as part of its three-year effort to ensure that U.S. shale supplies don’t leave the world with a surplus.

“In addition, prices are now at levels where we expect a supply response from both OPEC and US shale producers, pointing to only modest further downside potential,” Goldman Sachs said in its recent report.

Coronavirus uncertainty: what to do?

Though the oil prices have marginally recovered Wednesday, they are still below the levels to allow most OPEC members to cover their spending.

Talking of if the oil prices could slide further, Goldman Sachs says the “market is effectively pricing in a large oil demand shock.” However, the investment bank says it is difficult to estimate how it would hit the demand owing to an “uncertain trade-off between the aggressive policy response and the duration of the outbreak.”

Moreover, the company notes that uncertainty surrounding the spread of the coronavirus could “keep spot price volatility elevated.” Something similar was seen during the SARS epidemic.

Separately, president of Lipow Oil Associates, Andy Lipow notes that oil prices could drop further. “There could be another $5 a barrel downside in this because we simply don’t know the extent of the virus and how long it’s going to last,” he told CNBC.

For traders and investors who are looking for advice in such an uncertain environment, Goldman says their modeling suggests “depressed deferred Brent time spreads as offering a better opportunity to fade the significant pessimism reflected in the oil market.”

Thus, the investment bank recommends “entering a long Dec-20 vs. Dec-21 time spread Brent trade, with an initial value of negative 5 cents per barrel.”

On Wednesday, Brent traded around $54.22 a barrel, down 17% from the start of 2020. West Texas Intermediate crude (WTI) was trading at $49.81 a barrel, down 18% from the start of the year.

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