By Irina Slav
The coronavirus outbreak in China has hogged headlines for a month now, battering oil prices and sending OPEC into a frenzy to find a way to stop or at least slow down the decline while smaller U.S. producers struggle with pending debt repayments amid depressed prices.
And it could get worse.
Earlier this week optimism returned to stock markets and oil prices briefly rallied when suggestions began to emerge that the virus could have peaked. And then China changed its methodology of counting the new cases which meant the number shot up considerably, slowing the oil price rally. Stocks may have continued up, but oil has stubbornly remained low.
China is the world’s second-largest consumer of oil after the United States. It is also the world’s largest importer of oil, accounting for a bit more than 20 percent of all global oil exports. No wonder oil prices react to every piece of news coming out of China.
The immediate effect of the coronavirus outbreak on oil prices is easy to see. Quarantines have severely limited travel, dampening demand for fuel. State refiners have cut their processing rates by a tenth this month and will be cutting additionally in March, according to OilX. The combined cut for PetroChina, Sinopec, and CNOOC for February came in at around 940,000 bpd, according to a Reuters report. Private refiners cut even more, with OilX calculating the cut at 25 percent.
In a somewhat surprising turn of events, however, earlier today Bloomberg reported that independent refiners have gone on an oil-buying spree, taking advantage of the low prices.
Now, based on all that, one could argue that the negative effect of the epidemic on oil demand will be temporary and the moment the outbreak begins to die down along with the panic it caused, demand for oil products will begin to improve. Yet the outbreak could damage the Chinese economy enough to lead to a more prolonged period of subdued demand and oil prices, respectively.
China’s economy could slow down to a growth rate of 5 percent this year because of the coronavirus, Forbes’ Gaurav Sharma wrote this week. That would be 1 percentage point lower than what the International Monetary Fund forecast for the Chinese economy last month. GDP growth of 5 percent would still outperform the global economy, which the IMF sees growing by 3.3 percent this year, but it would be lower than what oil exporters have been hoping for. In an economy this large, every percentage point up or down makes a difference for prices.
In fact, China’s economy has become so essential for the global economy, it is what investors should watch to get investing insights. That and oil prices, MarketWatch’s Ivan Martchev said in a recent story. In it, he noted that the slowdown in the Chinese economy would have global repercussions and would hit energy stocks particularly hard.
“If the price of crude oil does what it did in 2015 — culminating in the January 2016 low of $26 per barrel — there is substantial downside for the stocks of both integrated energy companies and the more leveraged oil service ones,” Martchev wrote, noting that most energy stocks already underperform the indices because of lower investor confidence and persistent challenges coming from prices and the push for an energy transition to less polluting sources.
Not everyone is as concerned, however. Hedge fund legend Ray Dalio, for example, said that while the short-term effects of the coronavirus outbreak would be substantial, these may be exaggerated.
“I think the most likely outcome is that this virus will be a larger version of SARS that will have a significant temporary effect but won’t have a big long term influence, so the downward market price moves related to it are probably becoming exaggerated,” Dalio said in a LinkedIn post.
It is clear enough oil prices will remain subdued until the worst of the outbreak is over. The interesting question, then, is how much upside potential oil will have when this happens? Sadly, with a clear and present overhang in global supply, this may be limited, going on negative if the Libya oil port blockade ends anytime soon. If it continues the current course, however, and if Chinese demand rebounds quickly enough, there will be some good news for oil exporters.