Coronavirus is a "black swan" event for oil

The coronavirus outbreak is leaving the energy industry facing the prospect of no overall demand growth for the calendar year. 

The coronavirus outbreak is proving a “true black swan” for oil markets, Warren Pies of Ned Davis Research told CNBC. Chinese demand for oil is down by two to three million barrels per day (mbpd) – roughly a quarter below normal levels. That is leaving the energy industry facing the prospect of no overall demand growth for the calendar year. 

Trading above $54 per barrel at the start of this week, Brent crude is down almost 18% since 1 January. America’s benchmark oil future, West Texas Intermediate, fell below the $50 per barrel mark on Monday, a 13-month low. 

Opec has been sidelined

Plunging oil prices came as oil cartel Opec and ally Russia struggled to agree on a new round of supply cuts. Opec is already curbing output by 2.1 million bpd compared with a 2018 baseline and is urging Russia to join in with a plan for a further cut of 600,000 bpd. Yet Russia this week appeared reluctant to sign up to Opec’s strategy, arguing that it is too soon to assess the effect on demand of the coronavirus. 

The big Persian Gulf exporters are desperate for prices to rise, says Julian Lee on Bloomberg. Falling Chinese demand could cost them “more than half a billion dollars a month” at current prices. Opec and Russia may soon be forced to act. Having floated the idea of further cuts, anything less may well lower prices again. 

The Middle Eastern producers are in any case less central to oil markets than they once were, notes Samuel Burman of Capital Economics. The region accounts for about one-third of global production, down from 50% during the 1990 Gulf War. Flexible American frackers are able to step in quickly with new shale oil when prices rise. 

The result is that despite heightened geopolitical tensions in the Middle East, the oil “risk premium” has fallen in recent years. The risk premium is the extra price paid for oil over what would be justified by supply and demand fundamentals alone. When oil prices spiked to $147 per barrel in 2008, tension between Iran and Israel swelled the risk premium to more than $100 per barrel. Yet between 2015 and 2019 the risk premium has averaged just $7. At the end of last year the premium even went negative: traders were more worried about weak demand than about future supply shocks. 

The oil rout is unlikely to go on for much longer, says Tom Holland of Gavekal Research. With China gradually returning to work (see page 4), fuel demand could “return towards pre-epidemic projections as soon as the second quarter”. 

With West Texas Intermediate slumping to multi-month lows the pressure on cash-strapped US shale producers will grow. That should act as a brake on supply. Expect Brent to stage a modest recovery to average around $60 per barrel this year. 

Recommended

More upside to come for the oil price
Oil

More upside to come for the oil price

The Brent crude oil price its highest level since last February this week. And there could be more gains to come.
14 Jan 2021
How rising oil prices could prick the US stockmarket bubble
Oil

How rising oil prices could prick the US stockmarket bubble

Even with the coronavirus resurgent and much of the world going back into lockdown, the oil price is rising. That could deal a serious blow to the US …
8 Jan 2021
22 December 1973: Opec more than doubles the price of oil
This day in history

22 December 1973: Opec more than doubles the price of oil

On this day in 1973 Opec, the oil price cartel, more than doubled the price of oil from $5.12 a barrel to $11.65.
22 Dec 2020
My favourite oil stock has almost trebled since 2016 – but I’m hanging on to it
Oil

My favourite oil stock has almost trebled since 2016 – but I’m hanging on to it

Four years ago in his “trade of the lustrum” Dominic Frisby discovered that the best stock to use to bet on oil is not actually an oil stock. It’s bee…
9 Dec 2020

Most Popular

Why we won’t see a house-price crash in 2021
House prices

Why we won’t see a house-price crash in 2021

Lockdown sent house prices berserk as cooped up home-workers fled for bigger properties in the country. And while they won’t rise quite as much this y…
18 Jan 2021
Inflation is the easiest way out of this – just don’t expect politicians to admit it
Inflation

Inflation is the easiest way out of this – just don’t expect politicians to admit it

The UK government borrowed £34.1bn in December, a record amount for that month. Britain's debt pile now amounts to 100% of GDP. How are we going to pa…
22 Jan 2021
When will the US stockmarket bubble burst?
US stockmarkets

When will the US stockmarket bubble burst?

With US stocks more expensive than before the Wall Street crash of 1929, there are growing signs of “mania”. But what will push markets over the edge?
22 Jan 2021