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Mart 2, 2020

CORONA VIRUSAND NEW RISKS ON THE GLOBAL SUPPLY SIDE OF OIL

 

CORONA VIRUSAND NEW RISKS ON THE GLOBAL SUPPLY SIDE OF OIL

Oğuzhan Akyener

 

There are many elements that are affecting the prices in the oil markets. To have a generalization, we can assume that;

  • Supply – demand balances, including: new discoveries, stocks, number of drillings, production levels, interruption decisions, long-term contracts, development declarations and etc.
  • Economic trends, like: us dollar parity, alternative investment opportunities, purchasing power and etc.
  • Short or midterm risks, such as: perceptions, political tensions, terrorism, security issues, natural disasters, unusual factors, biological or chemical treats and etc.
  • Black oil capacity and prices are the main four categorized drivers of oil price equations.

World is consuming around a 100 million bbl oil per day. This means a very huge volume of economy. Some portion of this consumption (nearly %5) belongs to the unregistered black oil sales. From the supply side, there are important suppliers, which are affecting the equation. OPEC (maybe we can say that OPEC+) as being an integrated group of producers, is the most influential structure in the supply side of the equation.

From the demand side, USA and China are the two biggest consuming countries. That’s why, the acts, declarations or decisions of these players directly affect the price balances of oil.

Nearly from the beginning of the 2020, in addition to oil markets, all the global economic balances have been shaken by a biological treat: Corona Virus!  The Corona virus (which has started to spread in China and brought life to a halt)has caused oil prices to drop and then to remain at low levels despite all other enhancing factors.

Although there are many other elements which has to cause the prices up (such as the builds in US stocks, oil supply problems in Libya, Nigeria and Iraq, OPEC+ not to being able to agree on high levels of production cuts), Corona Virus by overturning all the balances, made the other effects nearly negligible.

But why? And how Corona Virus has such a great effect on oil prices?

The answer includes 3 types of effects, which are real demand drop, perceptional sight and indirect sight.

In addition, for the near future, we have to talk about other 2 types of effects, which are the global spread of Corona virus and unexpected halts in the producing fields.

From the sight of real demand drop, China (in the normal conditions) during pre-Corona Virus times used to have an average 13,5 million bbl / day oil consumption rates. This means nearly %13,5 of the global consumption is coming from the Chinese side. A sharp drop in China’s consumption will naturally clutters the prices. In this case, at the initial days of Corona Virus, when the Chinese government proclaimed a long holiday for the whole country and declares a curfew, due to break down of industrial and transportation demand, total crude consumption fall down around %40’s. This directly resulted in Brent prices to smashed to 50 $/bbl levels. After the extended curfew period ended, except the quarantined cities, life expected to turn into normal levels in the other lower risked regions of the country. But the situation didn’t go like that. These expectations initially made the prices up, but while the virus started to spread in a faster manner, nearly the whole country had to turn their houses and try not to go out as soon as possible. All economical acts, industrial production, meetings, trade flows and strategic plans shut down. Many countries canceled and suspended the flights with China. And this made the crude prices continue to drop, instead of the expected recovery period. In the February 2020, average Chinese daily consumption is estimated as being around 8 million bbl. Which means an average 5,5 million bbl / day drop in the direct global demand. This is the direct Chinese consumption drop effect on the crude prices.

Here we have to note that, the price reductions is continuing in spite of the Libyan supply cuts around 1,2 million bbl / day. If there were not cuts like that, then the prices would reach 47 $ / bbl levels (for Brent) and this would collapse (mostly US Shale oil producers) the supply side of the equation.

From the perceptional sight, apocalyptic scenarios related to the virus and fear of spreading to other countries can be accepted as the other type of (usually dropping) effect on the oil prices.

From the indirect sight, due to economic collapse and virus risks, all international transportation and trade flows badly affected and this resulted in an indirect global consumption decrease.

Currently, we are on the stage of a global spread and we are not sure how this period will affect the further scenarios. No one can model the biological risks and treat levels for different countries. Of course, the prices seem to continue to decrease due to additional demand risks and indirect or perceptional sights. But another important point is virus has started to spread in oil exporting countries also. This means the supply side of the equation will also start to decrease.

Virus spread risk will make oil companies to suspend their activities, delay their meetings, cancel their investments and in the worst case stop their productions. This will mean a break down in the supply side of the equation. In addition to this issue, the dropped levels of oil prices has also badly affected the smaller oil suppliers mainly in US and Canada. Nearly half of these types of companies are on the edge of bankruptcies. This means additional decreases in the supply side and in the further stages, we can expect some incremental fluctuations to reach the natural balanced levels.

As a result it is time to think about also the supply side of the global crude oil equation!

 

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