By Julian Lee
Oil traders will remain hard to convince that producers are doing enough, or reacting quickly enough
It’s finally upon us. The week when ministers from the oil producing countries of OPEC and their allies meet to decide on the future of their latest round of output cuts.
Having failed to persuade Russia to bring the meeting forward, Saudi Arabia will now hope to convince its biggest non-OPEC ally of the need to make deeper cuts in the face of a demand slump triggered by the Covid-19 virus. Success is not a foregone conclusion and failure will be costly.
The looming pandemic has already made its mark on oil markets. US West Texas Intermediate crude is now firmly below $50 a barrel and global benchmark Brent briefly followed it on Friday. That is uncomfortable territory for producers everywhere and, without a clear indication of deeper output cuts from this week’s meetings, prices will fall further.
As the virus spreads, locking down Italy’s industrial heartland and prompting Switzerland to ban large gatherings, producers appear to be clinging to overly optimistic demand assessments.
OPEC Secretary General Mohammad Barkindo, speaking at a conference in Saudi Arabia last week, said that in spite of the new coronavirus, the world’s “thirst for energy will continue to grow.” While that may be true for energy as a whole, it may not be for oil demand this year if there isn’t a quick rebound.
Assessments from the three main forecasting agencies still show 2020 oil demand growth running close to a million barrels a day, but that now looks very optimistic. By contrast, veteran energy consultants FGE cut their forecast for growth this year to “almost zero.”
They base their pessimism on the ripple effects of the virus beyond China, where traffic volumes in affected cities have already slumped, according to data from the TomTom Traffic Index. Measured in terms of how much longer journeys take than they would on empty roads, live data show that traffic volumes in Beijing are still well below normal levels, even as the city is reportedly returning to work.
In Wuhan, centre of the epidemic in China, there is no such uptick; economic activity remains severely curtailed.
But this is no longer just a Chinese problem. The economic impact of the spread of the virus to other parts of the world is clear. Four-week average jet fuel demand in the US has dropped by 18% in the past 10 weeks. Airlines are cutting flight schedules and passenger numbers have collapsed.
An acquaintance of mine flew back from Australia last weekend on a plane he reckons was only about one-third full. As people have second thoughts about getting on flights if there’s no guarantee those around them aren’t infected, flight schedules will almost certainly be cut further, with obvious implications for fuel demand. Consultants JBC Energy have cut global demand growth for the fuel to just 50,000 barrels a day this year, little more than a third of what they saw a month ago.
And those TomTom figures show the impact of the virus on traffic in Milan after its discovery in northern Italy. Morning rush-hour journey times have been cut by a quarter, as fewer cars clog the roads.
A similar pattern is emerging in OPEC nation Kuwait, where the virus has spread from neighbouring Iran.
Any hopes that demand will rebound last this year in a robust enough way to offset the first-half slump are built on shaky foundations. The flights that have been cancelled are gone, not postponed. The road trips not made this week won’t be made up in future weeks. Traffic may return to normal levels once the virus is brought under control, but there won’t be a surge beyond that from pent-up demand.
This is the situation that will face the oil ministers of the 23 nations in OPEC+ later this week. They need a credible plan that will take actual barrels off the market, even if Russia balks at making further cuts. Its compliance has been poor, but Saudi Arabia seems willing to accept that in return for the perception of added clout that it thinks Russia’s presence at the table brings.
I have no doubt that an agreement will be hammered out in Vienna - or via a virtual meeting if the gathering is cancelled. (There are no signs yet that it will be, though OPEC continues to monitor the situation in Vienna). The cost of failure is too great. It “would leave the market vulnerable to a short-term swing below $30 a barrel,” analysts Emily Ashford and Paul Horsnell from Standard Chartered said in a report.
Oil traders will remain hard to convince that producers are doing enough, or reacting quickly enough. Saudi Arabia’s oil supplies to China are set to fall by a third in March as demand withers. The kingdom is pressing OPEC+ producers to agree to collective production cut of an additional 1 million barrels a day - even that may no longer be enough.