At one point in mid-February, it looked like the Covid-19 virus outbreak was increasingly under control. In China, new cases were reported at a decelerating pace; although the death toll continued to rise, the spread of new infections had slowed down. Then three new hotspots of infection were detected: in the northern industrial heartland of Italy, in South Korea and in Iran. The cases emanating from these new hotspots started accelerating, spreading to the rest of Europe, North America, Latin America and Africa. The outbreak is far from over.
On this news, financial and commodity markets tumbled. Crude oil prices fell to fresh recent lows, with WTI plunging below US$50/b and Brent barely skirting that psychological level. The OECD reports that global economic growth for 2020 could be halved from previous forecasts to just 1.5%, taking Japan and the Eurozone into recession. This was based on the outbreak peaking in China, and mild outbreaks elsewhere. As recent news proves, that assumption looks unlikely, Covid-19 is now approaching the WHO’s definition of a pandemic.
The impact on demand will be vast. In China, industrial production ground to a halt as lockdowns were ordered. But with the new spread, the impact will be even greater, going beyond reduced jet fuel, road transport and petrochemical consumption to consumer demand destruction. Easter is approaching; in Europe, this is accompanied by a traditional spike in transport and consumer consumption. This is now at risk. Ramadhan is also approaching, also accompanied by increased transport and food consumption. This is now also at risk.
The increasingly rapid spread of the virus outside of China has prompted action from even the most reticent of quarters. After an aborted attempt in mid-February to convene an emergency OPEC+ meeting to discuss extending the current supply deal to June 2020, this may now be back on the cards. Russia, which reportedly did not sanction the extension of the deal, is now hinting that it is on board. Vladimir Putin, in an interview, stated that he recognised that ‘steps need to be taken to support oil prices’.
With the OPEC+ club scheduled to meet this weekend to discuss this very topic, any decision will have to be bolder than what was proposed before. This will either be a deeper cuts from existing levels through the end of Q2 2020, or extending the current supply deal through Q3 or even Q4 of 2020; or even a combination of both measures. But while the market may be assuaged by commitments, adherence is more important. The discussion will come at a time when Russian oil production increased by 3.2% y-o-y in February to 11.3 mmb/d. This figure includes condensate, explicitly excluded from the OPEC+ quotas, but does illustrate the continued problem within OPEC+: how to ensure members of the club stick to their pledges.
Beyond prices, there are also other worries. Iran now seems to be a hotbed of infection, with over 1,500 cases reported and 66 deaths recorded; the Covid-19’s average fatality rate of 2% suggests that reported cases in Iran are underestimated. This has implications for oil production and refining operations. With clusters of workers in close proximity, the potential for an infection outbreak on a rig, in a processing centre or in a refinery is high. Already, Shell’s Pulau Bukom refinery in Singapore, the company’s largest has reported a case, prompting a partial quarantine. If the virus was to break out in Iran’s oil facilities, the effect on output could be large. And not just Iran. The virus has already spread to Kuwait, Bahrain, Qatar and Saudi Arabia, traced back to Iran, increasingly the magnitude of potential impact. Of course, this would have a positive impact on prices, but on the whole, for the oil world to deal with a double whammy of demand destruction and reduced supply is a nightmare scenario.
It hasn’t happened yet. But it could. Hopes are now that the global government response to containing the virus moves into serious mode, this will not come to pass. But the risk is there; and in a flip side of the usual risk scenario for oil prices, crude is now trading at a risk discount rather than a risk premium. And until the Covid-19 outbreak has been confidently declared to be contained worldwide, this risk discount will persist and crude prices will remain depressed.
The Covid-19 Global Outbreak:
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