Just after the calendar officially turned over to 2020, reports from China suggested that a ‘new strain of viral pneumonia of an unknown cause’ had been detected in the city of Wuhan. As investigations began, normal life continued, which included the mass movement of several million people in Wuhan and the surrounding Hubei province in preparation for the Lunar New Year festivities. As the extent of pandemic became apparent, Wuhan was placed on virtual lockdown on 23 January; several other cities in Hubei – totalling almost 60 million people – followed suit. The World Health Organisation declare the Wuhan Coronavirus Outbreak a ‘global emergency’, as the first death outside of China was declared in the Philippines.
Traced to the Huanan Seafood Wholesale Market in Wuhan, a mutating melting pot for infections with the cramped presence of all forms of live animals, domesticated and wild – the Wuhan pandemic has now exceeded the 2003 SARS crisis in terms of infections, nearing 20,000 in over a month vs just over 8,000 over five months. Infections and deaths have been mainly localised to China, with over 26 countries have reported cases (vs 29 for SARS). The University of Hong Kong predicts that the cases in Wuhan alone could peak at 75,000. In response, China has curtailed outbound travel, other countries have closed their borders to visitors with recent travel to China and airlines have cancelled thousands of flights. Economic activity in Hubei – as well as other Chinese provinces – has slowed down, with orders to work from home and public/private transportation banned. Given that the Wuhan Coronavirus is only in its second months, it is very likely that its broader impact will be far greater than SARS.
But let’s focus on its impact on oil. Crude oil prices plunged as the impact of the Wuhan pandemic deepened. Much of this is sentiment-based, pricing in a long-lasting economic disruption on pessimistic expectations of the outbreak. How true is this prognosis? In 2003, a similar fall in crude prices accompanied the SARS crisis. However, this cannot be a true parallel as coordinated OPEC efforts reduced crude prices that had risen as the US invaded Iraq at the same time. In China, the SARS effects on oil demand was broadly localised to one quarter – Q2 – and then also localised to one product – jet fuel. LPG, naphtha, gasoline and gasoil demand were relatively unaffected, with annual growth of 8-12% for the year vs 1% for jet fuel (which had grown by 28% the previous year). Will the Wuhan pandemic follow this pattern?
There is reason to believe it won’t. Take jet fuel. In 2003, Chinese jet fuel demand was 160,000 b/d; in 2019, it has grown six-fold to 860,000 b/d. In 17 years, China has become increasingly more connected to the world by air. The SARS crisis affected an estimated 21% of jet fuel demand in 2003. Apply that to 2019 and over 180,000 b/d of jet fuel demand could be eliminated. With the government placing restrictions on domestic and international air travel in China – something that was only implemented partially during SARS – the effect could be even higher. There is also global jet fuel demand to consider. As major airlines scale back or even cancel all flights to China, it will be tough times depending on how long the pandemic lasts. Refining margins for jet fuel in Asia are now at their lowest level in 4 years.
Other fuel products could be affected. Unlike SARS, China been praised for its speedy response to the pandemic – including extended civil lockdowns, activity shutdowns and extending official holiday periods – but that has curtailed tourist activity, transport movements and manufacturing operations. Gasoline and gasoil, in particular, will be impacted by this. Against a backdrop of already-decelerating oil and gas demand, Standard Chartered estimates that the Wuhan pandemic could reduce oil demand growth in 2020 from 1 mmb/d to 900,000 b/d – a 10% fall. A lot will depend on how soon and how well the pandemic can be contained. This new pandemic might not be as fatal as SARS thus far, but its effect on oil demand could be graver.
SARS vs Wuhan Coronavirus:
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Recent headlines on the oil industry have focused squarely on the upstream side: the amount of crude oil that is being produced and the resulting effect on oil prices, against a backdrop of the Covid-19 pandemic. But that is just one part of the supply chain. To be sold as final products, crude oil needs to be refined into its constituent fuels, each of which is facing its own crisis because of the overall demand destruction caused by the virus. And once the dust settles, the global refining industry will look very different.
Because even before the pandemic broke out, there was a surplus of refining capacity worldwide. According to the BP Statistical Review of World Energy 2019, global oil demand was some 99.85 mmb/d. However, this consumption figure includes substitute fuels – ethanol blended into US gasoline and biodiesel in Europe and parts of Asia – as well as chemical additives added on to fuels. While by no means an exact science, extrapolating oil demand to exclude this results in a global oil demand figure of some 95.44 mmb/d. In comparison, global refining capacity was just over 100 mmb/d. This overcapacity is intentional; since most refineries do not run at 100% utilisation all the time and many will shut down for scheduled maintenance periodically, global refining utilisation rates stand at about 85%.
Based on this, even accounting for differences in definitions and calculations, global oil demand and global oil refining supply is relatively evenly matched. However, demand is a fluid beast, while refineries are static. With the Covid-19 pandemic entering into its sixth month, the impact on fuels demand has been dramatic. Estimates suggest that global oil demand fell by as much as 20 mmb/d at its peak. In the early days of the crisis, refiners responded by slashing the production of jet fuel towards gasoline and diesel, as international air travel was one of the first victims of the virus. As national and sub-national lockdowns were introduced, demand destruction extended to transport fuels (gasoline, diesel, fuel oil), petrochemicals (naphtha, LPG) and power generation (gasoil, fuel oil). Just as shutting down an oil rig can take weeks to complete, shutting down an entire oil refinery can take a similar timeframe – while still producing fuels that there is no demand for.
Refineries responded by slashing utilisation rates, and prioritising certain fuel types. In China, state oil refiners moved from running their sites at 90% to 40-50% at the peak of the Chinese outbreak; similar moves were made by key refiners in South Korea and Japan. With the lockdowns easing across most of Asia, refining runs have now increased, stimulating demand for crude oil. In Europe, where the virus hit hard and fast, refinery utilisation rates dropped as low as 10% in some cases, with some countries (Portugal, Italy) halting refining activities altogether. In the USA, now the hardest-hit country in the world, several refineries have been shuttered, with no timeline on if and when production will resume. But with lockdowns easing, and the summer driving season up ahead, refinery production is gradually increasing.
But even if the end of the Covid-19 crisis is near, it still doesn’t change the fundamental issue facing the refining industry – there is still too much capacity. The supply/demand balance shows that most regions are quite even in terms of consumption and refining capacity, with the exception of overcapacity in Europe and the former Soviet Union bloc. The regional balances do hide some interesting stories; Chinese refining capacity exceeds its consumption by over 2 mmb/d, and with the addition of 3 new mega-refineries in 2019, that gap increases even further. The only reason why the balance in Asia looks relatively even is because of oil demand ‘sinks’ such as Indonesia, Vietnam and Pakistan. Even in the US, the wealth of refining capacity on the Gulf Coast makes smaller refineries on the East and West coasts increasingly redundant.
Given this, the aftermath of the Covid-19 crisis will be the inevitable hastening of the current trend in the refining industry, the closure of small, simpler refineries in favour of large, complex and more modern refineries. On the chopping block will be many of the sub-50 kb/d refineries in Europe; because why run a loss-making refinery when the product can be imported for cheaper, even accounting for shipping costs from the Middle East or Asia? Smaller US refineries are at risk as well, along with legacy sites in the Middle East and Russia. Based on current trends, Europe alone could lose some 2 mmb/d of refining capacity by 2025. Rising oil prices and improvements in refining margins could ensure the continued survival of some vulnerable refineries, but that will only be a temporary measure. The trend is clear; out with the small, in with the big. Covid-19 will only amplify that. It may be a painful process, but in the grand scheme of things, it is also a necessary one.
Infographic: Global oil consumption and refining capacity (BP Statistical Review of World Energy 2019)
|Region||Consumption (mmb/d)*||Refining Capacity (mmb/d)|
*Extrapolated to exclude additives and substitute fuels (ethanol, biodiesel)
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Source: U.S. Energy Information Administration, based on Bloomberg L.P. data
Note: All prices except West Texas Intermediate (Cushing) are spot prices.
The New York Mercantile Exchange (NYMEX) front-month futures contract for West Texas Intermediate (WTI), the most heavily used crude oil price benchmark in North America, saw its largest and swiftest decline ever on April 20, 2020, dropping as low as -$40.32 per barrel (b) during intraday trading before closing at -$37.63/b. Prices have since recovered, and even though the market event proved short-lived, the incident is useful for highlighting the interconnectedness of the wider North American crude oil market.
Changes in the NYMEX WTI price can affect other price markers across North America because of physical market linkages such as pipelines—as with the WTI Midland price—or because a specific price is based on a formula—as with the Maya crude oil price. This interconnectedness led other North American crude oil spot price markers to also fall below zero on April 20, including WTI Midland, Mars, West Texas Sour (WTS), and Bakken Clearbrook. However, the usefulness of the NYMEX WTI to crude oil market participants as a reference price is limited by several factors.
Source: U.S. Energy Information Administration
First, NYMEX WTI is geographically specific because it is physically redeemed (or settled) at storage facilities located in Cushing, Oklahoma, and so it is influenced by events that may not reflect the wider market. The April 20 WTI price decline was driven in part by a local deficit of uncommitted crude oil storage capacity in Cushing. Similarly, while the price of the Bakken Guernsey marker declined to -$38.63/b, the price of Louisiana Light Sweet—a chemically comparable crude oil—decreased to $13.37/b.
Second, NYMEX WTI is chemically specific, meaning to be graded as WTI by NYMEX, a crude oil must fall within the acceptable ranges of 12 different physical characteristics such as density, sulfur content, acidity, and purity. NYMEX WTI can therefore be unsuitable as a price for crude oils with characteristics outside these specific ranges.
Finally, NYMEX WTI is time specific. As a futures contract, the price of a NYMEX WTI contract is the price to deliver 1,000 barrels of crude oil within a specific month in the future (typically at least 10 days). The last day of trading for the May 2020 contract, for instance, was April 21, with physical delivery occurring between May 1 and May 31. Some market participants, however, may prefer more immediate delivery than a NYMEX WTI futures contract provides. Consequently, these market participants will instead turn to shorter-term spot price alternatives.
Taken together, these attributes help to explain the variety of prices used in the North American crude oil market. These markers price most of the crude oils commonly used by U.S. buyers and cover a wide geographic area.
Principal contributor: Jesse Barnett