What Coronavirus Really Means for the Oil Market
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What Coronavirus Really Means for the Oil Market

by | published January 29th, 2020

This morning as I write this, both primary crude oil benchmarks – WTI (West Texas Intermediate, the standard for future contracts in New York) and Brent (the more broadly used global yardstick set daily in London) – are modestly improving, up 0.8 percent and 1.3 percent, respectively. This follows slight gains by close yesterday (0.6 and 0.5 percent).

However, the last week has been quite a different story. For the five days of trade through close on Monday, WTI had retreated a hefty 8.9 percent while Brent was down 8.4 percent. And the current WTI improvement has as much to do with an unexpected decline in US inventories than any better view of the underlying cause of the preceding drop.

Present crude prices are not reflecting oil supply and demand considerations. This is all about coronavirus (or what is becoming known as the Wuhan flu after the Chinese city where it emerged), the latest Chinese disease scare. Now this is not yet a true global crisis, although documented cases in China now exceed 6,100. To put that in perspective, the total is already greater than the SARS cases (also a coronavirus) in 2002-2003. That was the last epidemic that impacted oil prices in a similar manner.

Why the connection?

The Market’s Reaction is More Panic than Pain

Most of the “analysis” spooned out in 60-second (or less) snippets by talking heads on TV ascribe it to the expected (but as yet completely undocumented) adverse impact the flu will have on international economies. That, in turn, is calculated into a decline in energy demand despite there being no statistical basis for the move.

True, there have been some restrictions on travel to and from China. In addition, given that the situation hit during the Chinese New Year, the negative impact on holiday spending in China and the broader region will be significant.

But both will pass. Once again, the kneejerk reaction has provided an opportunity for some big money interests to short oil futures, moving back in on the long side once the crisis du jour has passed. The decline in oil prices is more a manifestation of profit opportunities on the margin of trading than it is a genuine statement on market conditions.

The real reason for this latest outbreak is the same as those for the SARS outbreak and the swine flu that plagued China. It comes from what is usually labeled the “wet market.” This is where diseases emerging from non-human sources are transferred to humans when unregulated slaughtering of wild animals occurs. This remains a problem throughout China and elsewhere in Asia. It is also hardly a new development. I personally experienced such an environment over four decades ago in local street markets. Diseases usually confined to fauna in the bush move into the human food chain via the unsupervised killing of non-domesticated animals.

This episode is another reminder that events quite outside the normal environment of the energy sector can have sporadic, and rather dramatic, effects on how much energy pundits believe the market needs. That these are outlier factors hardly lessen the impact.

It is primarily an emotional response, one also fueled by an administrative overreaction in China. The last time commentators were using the term “pandemic” to refer to what was happening in China, Beijing stonewalled.

China’s Road to Recovery

Today, Chinese officials are closing entire cities and regions, affecting over 35 million people while domestic travel is curtailed. That simply provides additional fodder for doomsayers.

We can anticipate a recovery in oil prices once two actions are taken, both in China. First, a closing of wet markets (admittedly easier said than done, especially in rural areas). Second, when the result of segregating those affected kicks in. This is hardly a long-term crisis.

Nonetheless, there is no reason to tempt the disease gods. I have delayed a journey to Vietnam and the surrounding area scheduled for next month.

The trip was to assess the most recent developments in the South China Sea, where Chinese officials have accused the U.S. of “deliberate provocations” after a recent freedom of navigation operation by the USS Montgomery near the Spratly Islands.

For all of our sakes, let’s hope that these confrontations never come to anything more than saber-rattling. But the Pentagon isn’t taking any chances, pumping millions of dollars into a small defense contractor with a staggering new technology designed to stop Chinese aggression in its tracks. Here’s what you need to know.

I am still supposed to be appointed as an advisor to Petrovietnam, the Vietnamese state oil company. That assumes the politics can be worked out and I can secure an agreement from the US Department of State to allow a valid risk assessment.

I can always reschedule going over. After all, the South China Sea crisis will still be there after the Wuhan flu crisis has come and gone.

Sincerely,

Kent

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