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Coronavirus and the unexpected risk to oil demand

Coronavirus and the unexpected risk to oil demand
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Over the weekend and into Monday, rocket attacks targeted the U.S. embassy in Baghdad, and Libya’s tenuous ceasefire faltered. Close to 1.2 million barrels of oil a day (mbds) was taken out of production in Libya just last week. The result: Oil prices were down to a three-month low on Monday, dropping to below $60 a barrel for Brent oil, and some expect it to fall to the mid-$50s.

What a few weeks ago would have led to a jump in prices is today not boosting prices.

The geopolitical security premium is waning under the increasing uncertainty of what’s happening in China. Fear is now a security threat. 

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What is moving oil markets is the novel coronavirus. As of January 29, there were nearly 6,000 confirmed cases of the virus, mostly in China. The United States has 5 confirmed cases. Thailand, Europe, Japan, Singapore and South Korea also have confirmed cases. With each day, the reports show increasing numbers of infected and growing geographical reach. China is moving into overdrive to contain the virus, but there are many challenges. The timing of the outbreak could not have been worse for China. 

It is Lunar New Year in China. Typically, it’s a time of celebrations and travel across the country and beyond. Last year over the 40-day festival, there were 3 billion trips recorded. This year expect a 30-50 percent drop in total travel. In a note on Monday, RBC showed how the virus and its reach are hitting China’s jet fuel demand. Beijing cancelled many of the scheduled Lunar New Year festivities, and there are four or more cities on lockdown. Taken together, more than 18 million people are prohibited from traveling out of their towns, and 40 million are on travel restrictions.  

As the virus spreads, and more cases are reported, its effect on the global economy is a major concern. Markets beyond China are down, with the Dow posting a 450-point drop at the start of a week. Airline stocks are taking a hard punch as travel bans take effect and concerns escalate about the virus’ impact on international travel. Fear and efforts to contain the scope of the impact have already pushed British Airways to halt all travel in and out of China. Many other international and U.S. airlines are expected to follow suit. 

We are already witnessing a direct hit on oil demand. China is the world’s largest importer of oil, with over ten (mbd) in 2019. A dramatic slowdown in air travel, and closure of offices and manufacturing plants and stoppages on infrastructure projects, means a deepening impact on demand at a time of weakening overall global demand.

The World Economic Forum considered China, geopolitics and strained health systems specific risks for 2020 in its Global Risks Survey. Eurasia Group noted U.S./China as its number three global risk. But a spreading deadly virus was missing from both assessments. It’s still too early to tell, but the growing threats resulting from the coronavirus could prove to be the greatest risk of 2020, and the one that not only pushes markets down, but also puts pressure on China’s political leaders in a way that few could have imagined less than two weeks ago.  

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If we go back and consider the risks and events of 2019, there were many. In the oil markets, oil traders were the winners from the multitude of global risks. 2019 was a bumper year for traders — many trading firms reported record earnings. Why? Volatility. Last year brought ample opportunities for the market to gyrate both up and down. The September attacks against Saudi Arabia’s petroleum infrastructure, which affected 5 percent of global supply, was just one of many stories that drove prices up. The ongoing and still unresolved U.S.-China trade war was responsible for both sell-offs and buys. All in all, the geopolitics of energy was in full swing, with market activity high. Traders were enjoying days of movement and revenue opportunities.  

Less than a month into 2020 and global risks to global economic growth are gaining momentum. China will be the hardest hit by the coronavirus. But other economies, including the United States, will feel the impact. 

The coronavirus has tremendous repercussions for several sectors, and if it continues to spread, expect a rough ride for oil. Middle East tensions are many, and even with rocket attacks in Baghdad, the collapse of the ceasefire in Libya and ongoing threats from Iran, the price continues to drop. 

OPEC at first downplayed the impact of the virus, indicating that it wouldn’t do much to demand and price. But as the infection’s magnitude and spread become clearer, OPEC+1 is responding with a call to extend the 1.7 (mbd) production cut past March. The possibility of a deeper cut is in the cards. Something will need to hold the price floor steady. 

2020 appears to be a year when traditional risks to supply and demand continue to play a role. But there are also new and emerging risks, coronavirus being the first, that will catch markets by surprise and challenge forecasts. 

Carolyn Kissane, academic director and clinical professor of global affairs at the Center for Global Affairs at NYU School of Professional Studies. She is a non-resident fellow at the Payne Institute for Earth Resources.