By Alex Kimani
Just when investors were beginning to come to terms with weak oil demand amidst a synchronized global economic slowdown, a deadly viral outbreak in the world’s most populous nation has put paid hopes for a quick recovery and placed the oil market in danger of a complete meltdown.
Asian jet fuel refining margins have now seen their biggest monthly fall in over 10 years.
Global demand for jet fuel is expected to take a big hit after a series of carriers suspended flights to China amid the marauding coronavirus that has so far claimed 362 lives and infected another 17,300 people across the globe.
Key international airlines that have cancelled or reduced flights to China include British Airways, Lufthansa, American Airlines, United Airlines, Austrian Airlines and Swiss International Air Lines. Jet crack spreads — a metric that measures the differential between an oil product and the crude from which it is derived — have already narrowed against Brent crude amid expectations of lower demand.
Things could get a lot worse if more airlines follow suit.
China’s foreign ministry has slammed the United States for setting a “very bad example” after Washington temporarily banned foreign nationals who have traveled to China within the past two weeks entry into the country. Australia, Japan, Italy, Russia, Pakistan and Singapore have announced similar restrictions.
Minding the Crack
Cracks, or refining margins, are trouncing oil right now. In January alone, the jet fuel crack for JETSGCKMc1 (the benchmark Singapore refining margin) plunged 34%–a rate that hasn’t been witnessed since the spring of 2009, according to Refinitive Eikon data cited by Reuters.
Jet fuel crack spreads have narrowed considerably in anticipation of weak demand, with the Singapore jet/kero crack spread currently $8.88/b, down from $11.34/b as of January 20 as per Platts data. The Rotterdam jet/kero crack finished last week at $12.90/b, down from $14.17/b January 20 while the US Atlantic Coast jet crack finished the week at $12.68/b, down from $14.18/b January 17. As we explained in a previous article, crack spreads can be used to gauge demand with narrowing spreads a harbinger for weak demand.
China is a major demand hub for jet fuel, with the IEA pegging Chinese jet/kerosene demand at 858,000 b/d in 2019, or 10.7% of global jet fuel demand of 8.01 million b/d.
One jet fuel trader has told S&P Platts that further flight cuts could prove to be a game changer in an already depressed market with S&P Platts estimating that a single flight to China carries around 80-90 metric tonnes of jet fuel.
The China situation has turned the oil outlook strongly bearish, with the European jet market already weighed down by weak demand due to seasonality. Platts Analytics has forecast a catastrophic drop in oil demand of 2.6 million b/d in February and 2 million b/d in March, in its worst-case scenario against global oil demand of 100.83 million b/d. A best-case sees demand dropping by 900,000 b/d in February and 650,000 b/d in March.
The viral outbreak could wreak even more havoc by slowing down the world’s second biggest economy. IHS Markit estimates that the epidemic could lead to a 1.1-percentage-point reduction in Chinese economic growth from its baseline forecast of 5.8 percent growth this year. IHS Markit has based its estimates on a benchmark crafted during the SARS outbreak in 2003.
Another bear market?
With the recent spate of poor earnings coming from the energy sector, it appears that oil stocks are doomed to remain in the doldrums a lot longer than we could have hoped for. ExxonMobil (NYSE:XOM), Royal Dutch Shell (NYSE:RDS.A) and Chevron Corp. (NYSE:CVX) have all reported disappointing Q4 earnings, setting the tone for another round of selloffs. The sector’s favorite benchmark, XLE, is down 11.7% in the year-to-date.
As Nick Cunningham of OilPrice has reported, Wall Street and investors are rapidly cooling off on the sector and even juicy dividends are no longer enough to persuade them to stick around. Jim Cramer says fossil fuels are done and it’s only a matter of time before demand growth hits a plateau and finally reverses course.
S&P Platts is more sanguine, and expects the impact of the coronavirus to fizzle out by June-July.
As the lackluster response to a series of crises and high-profile incidents in the Middle East has shown, oil prices are now driven by demand-side indicators, and one of the biggest drivers is the Chinese economy, which now trumps anything that can happen in or regarding Iran.
China’s growth forecasts are now being tweaked, and global stocks had lost $1.2 trillion in two weeks, as of the close on Friday–even if European markets have stabilized somewhat on sentiment that the virus isn’t accelerating its spread on the continent.
But what Platts is sanguine about is what it sees at a one-off impact on jet fuel, and Wood MacKenzie agrees, seeing a recovery in the second half of 2020.