Julian Lee and Tyler Cowen: Producers in panic as coronavirus to infect global oil prices

The new coronavirus will take a chunk out of China's oil demand. Producers must respond with an output cut.

Julian Lee and Tyler Cowen: Producers in panic as coronavirus to infect global oil prices

The new coronavirus will take a chunk out of China's oil demand. Producers must respond with an output cut.

The extent to which the outbreak will reduce fuel demand in China is not yet known, but Opec+ producers must respond with an output cut, say Julian Lee and Tyler Cowen.

Oil producers are feeling the impact of coronavirus as it spreads, and they need to act to head off a devastating fall in prices.

The world’s biggest producers face two key questions: how long will the outbreak last and how severe will the consequences be?

The Opec+ group of nations must make some educated guesses soon.

Their initial reaction resembled the frantic scurrying of an anthill. Last week, there were calls for their next meeting, scheduled for the first week of March, to be brought forward, perhaps by a month.

That suggestion, by Saudi Arabia, Opec’s biggest producer, initially found little support from the largest of the non-Opec members of the wider group, Russia.

One of the key challenges for the Organization of the Petroleum Exporting Countries and its big oil-producing counterparts is that they have no idea how big a problem they face.

Estimates of the epidemic’s impact on oil demand vary widely. S&P Global Platts sees global oil demand falling by an “almost catastrophic” 2.6m barrels a day in February and 2m barrels in March, in its worst-case scenario.

No wonder producers are in a panic.

China is by far the biggest market for Opec+ crude exports, with the big Arabian Gulf producers particularly vulnerable.

Tanker-tracking data, compiled by Bloomberg, show that almost a quarter of all shipments out of the region last year went to China.

Add in the other three big Asian buyers — India, Japan, and South Korea — and that share rises to two thirds.

Four Asian countries took two thirds of the crude passing through the Strait of Hormuz in 2019; China took almost a quarter.

It is difficult to overestimate the importance of China to global oil balances. Earlier this month, Opec forecast that the world’s most populous country would account for more than a quarter of all the growth in oil demand worldwide this year.

The International Energy Agency predicted 40% of incremental demand in China. The word “virus” didn’t appear in either of those agencies’ monthly reports.

The virus will not affect all oil products equally. With travel bans and an extended Lunar New Year holiday, transport fuels will be hit hardest.

Petrol, jet fuel, and gas/diesel oil were expected to account for 55% of China’s oil demand this year and make up almost 60% of the growth.

Transport fuels, likely to be hardest hit by the virus, account for 60% of forecast Chinese demand growth this year.

Flight bans to China by many airlines, including British Airways Plc and Delta Air Lines Inc, and travel restrictions on Chinese tourists, will have a knock-on effect on fuel use elsewhere, particularly in nearby countries that are favoured destinations for tour groups.

And there are other knock-on effects. Lower demand from end users means lower demand from refiners.

Major, state-owned Chinese refiners may cut run rates below 70% to cope with falling demand, industry consultant JLC said, while operating rates at privately-owned independent refineries in the eastern Chinese province of Shandong may be cut to below 50%.

Almost all of China’s biggest crude suppliers are Opec+ members. Even before coronavirus began to affect oil consumption, the swing producers that make up Opec+ were in trouble.

The hard-won output deal they reached in December failed to deliver any significant cuts to total output levels, and prices have drifted lower.

The deal’s scheduled to expire at the end of March. Simply extending the cuts will do nothing to improve the worsening balances between supply and demand, and it will take more to light a fire under oil prices.

Deeper cuts will be much harder to agree — Russia, for one, is against them — but that’s the only thing that will lift prices in the face of a Chinese slowdown.

There are signs that slowdown is happening. Sales of Latin American oil cargoes to China ground to a halt last week.

Arabian Gulf producers are receiving preliminary nominations from their customers of how much oil they want in March, and that will indicate whether Chinese refiners seek to reduce the volumes they lift from export terminals in the region.

Non-Opec countries — led by the US, Norway, Brazil, and new producer, Guyana — were already expected to add two extra barrels for every additional one consumed worldwide this year, squeezing Opec.

The loss of much of China’s oil-demand growth will crush the producer group under the weight of falling oil prices, unless, collectively, they cut their output further.

Separately, there has been talk about how the coronavirus might erode trust between the Chinese public and its leadership.

In the US, however, the coronavirus is likely to have the opposite effect: to increase the re-election chances of the president, Donald Trump.

The public-health and economic risks of the virus are significant, and it could be a front-page story for months.

Even if the coronavirus does not lead to many deaths in the West, that risk will continue for some time, and quarantines and travel bans will continue.

That will make Trump’s nationalism seem understated. Hundreds of flights to China have been cancelled, countries are refusing to receive (or deciding to quarantine) Chinese nationals or visitors from China, and China is severely limiting travel within the country.

Travel bans no longer seem unconstitutional, even if voters are confusing normal times with times of pandemic.

When the flight of Americans returning from Wuhan was sent to Alaska last week, instead of San Francisco, and subject to quarantine, very few political complaints were heard, including from leading Democrats.

There might still be arguments about whether that was a justified violation of civil liberties, but the notion that a pandemic requires the federal government to take such measures, without a congressional vote, is not seriously contested.

That is going to help any incumbent US president who believes in the strong exercise of executive power, as does Trump.

Trump’s suspicions about China also now seem to be more justified. Of course, they have been more about trade and foreign policy than public-health.

Still, the general feeling being conveyed by the news — “Bad Things Are Coming Out of China” — makes Trump seem prescient, regardless of whether his views are justified.

American voters are more likely to harbour negative feelings toward China and to support a nationalistic stance. Whether the issue is trade or pandemics is a second-order detail.

If the coronavirus continues to be an issue in the build-up to the US general election in November, it might discourage large public gatherings and thus make it more difficult for the challenger to campaign.

The incumbent can appear presidential by implementing policies — such as increased vaccine production — that any president would.

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