Crude rebounded on Tuesday, as OPEC and its allies convened what amounts to an emergency meeting in Vienna in order to conduct an “urgent” assessment of how the coronavirus outbreak is likely to impact demand for crude, which plunged 16% last month in the worst start to a year since 1991.
As I put it over the weekend, the oil market’s latest (black) swan dive is a testament to just how persistent demand concerns really are amid a still-tenuous outlook for global growth. And it underscores the primacy of those concerns even in an environment plagued by worries on the supply side. Libya’s output, for example, recently fell to the lowest in nine years, as the country’s intractable civil war drags on.
Bets against WTI spiked more than 50% in the week through last Tuesday. It was the largest increase in nearly 18 months.
A Chinese official was invited to attend the OPEC+ pow wow. The appearance of Wang Qun – Beijing’s ambassador to international organizations in Vienna – reflects just how critical an input China is in the demand equation for crude.
The country’s oil demand plunged recently by around 3 million barrels/day, amounting to 20% of total consumption, Bloomberg reported late last week, citing “people with inside knowledge of the country’s energy industry”.
If the coronavirus epidemic continues to worsen, dragging down the Chinese economy, oil demand will suffer at a delicate juncture.
Crude’s recent plunge telegraphs a sizable hit to the global economy from the virus, Goldman’s Damien Courvalin said Monday. “Spot Brent oil prices have declined $11/bbl since January 17, when 2019-nCov outbreak in China became front and center of market and media attention”, he wrote, adding that “with most of this move driven by a flattening of the forward curve, the market is effectively pricing in a large demand shock and commensurate increase in inventories”.
After leveraging Goldman’s pricing model to estimate the demand hit being priced in, Courvalin says “oil prices and timespreads reflect a -0.44% hit on global GDP and -750 kb/d on oil demand from the coronavirus alone”.
That’s not trivial – especially at a time when global growth is coming off the worst year since the crisis.
Amusingly, the estimate from Goldman’s commodities team is bigger than the worst case scenario posited by the bank’s economists, which suggests “the oil market is already pricing in a significant demand shock relative to other assets”.
Why is that? Well, two reasons. First, positioning was stretched, and second, the same gamma effects that hit the market in November of 2018, worsening the rout, may have been at play again.
“Geopolitical tensions at the start of the year and a tight physical market had left speculative positioning at elevated long levels as recently as last Tuesday based on the CFTC data [and] the large amount of producer hedging in late 2019 and early 2020 has created elevated levels of put open interest at Brent strikes between $55 and $60/bbl”, Courvalin notes.
And then there’s CTAs. “The declines in oil prices have likely been exacerbated by CTAs, with our momentum signals for WTI first turning short a few weeks ago and both short- and long-term momentum turning bearish for Brent on January 24th”, JPMorgan said, in a Friday note.
So, what to do? The implication from this is obviously that crude prices may have overshot to the downside, even compared to some of the more dour projections of the global economic impact of the burgeoning pandemic. Goldman says as much.
“We find that the latest sell-off has left the oil market pricing in a likely excessive demand hit, with only modest further downside potential [and] we would expect a supply response from both OPEC and shale producers, and where China would likely seek to build crude inventories”, the bank goes on to say.
But folks are spooked. For instance, IHS Markit’s Roger Diwan called this “the worst crisis, at the worst place, and the worst time” for crude, and reckons OPEC “has no option but to cut production as China is going to buy a lot less”.
BP warned that the virus outbreak could potentially eliminate up to one third of global oil demand growth this year. Later, CFO Brian Gilvary said prices may loiter near $55 a barrel in the near term.
“Admittedly, uncertainty on the spread of the virus can keep spot price volatility elevated, as was the case during the SARS epidemic and through today’s price action”, Goldman’s Courvalin concedes.
The ball is, for now, in OPEC (and Russia’s) court. To quote Donald Trump, “we’ll see what happens”.