Oil and Covid-19 part one: The route back
While the potential for a global pandemic that cripples the world economy and the oil price remains, thoughts are beginning to turn to what happens post-coronavirus
Countries across large swathes of North America, Europe, the Middle East, east Asia and Australia have confirmed a growing number of Covid-19 cases, causing concerns that the virus could yet circumvent efforts to contain its spread and move to a full-blown global pandemic.
The impact of such a scenario on the global economy, both on energy demand and the price of oil would be substantial. Even the disruption that the efforts of China, in particular, and other badly affected countries to reduce the disease’s spread has caused have likely had a negative impact on global economic growth.
“Supply chains have become very integrated, with intermediary products crossing multiple boundaries before the final good is exported. When you are trying to model what effect a slowdown in goods and people movement will have on the global economy and on supply chains, everything is very difficult to quantify,” says Joel Hancock, lead energy analyst at bank Natixis. “When we do have worse news, it may make sense for the market to panic slightly and sell-off.”
The oil market has certainly been prepared to sell-off, pricing in a substantial Covid-19 material impact, although a pandemic would inevitably put additional downward pressure on prices. The benchmark Brent price, which was hovering around $70/bl in the first half of January, as the market digested the US assassination of a leading Iranian general, tumbled to finish February at under $50/bl.
But, assuming that Covid-19 can be contained outside of China—where current signs point to the worst of the outbreak being over for now—its disruptive impact will be short-term. Global supply chains will be restored and any dip in GDP will be temporary. So, too, assuredly, for oil demand and price. And the timing of that recovery and what it looks like are beginning to enter the market’s thoughts, even if it is too early to yet unwind discounts that account for less happy scenarios.
What is slightly ironic is that the weeks-long slide in crude on the back of weakening Chinese demand has actually come ahead of any material drop in the country’s imports, according to market watchers. Talking to Petroleum Economist at London’s IP Week at the end of February, Alex Booth, head of market analysis at cargo tracking specialist Kpler, noted that there had been an identifiable dip in Chinese imports—which tend to be volatile on a day-to-day basis anyway—only in the previous two weeks, and that there was even the sign of a rebound since then.
Sinopec has been hardest hit
The lack of a sustained drop-off in imports has been the “biggest surprising factor”, says Booth. “It is more muted than people expect.” The arrival of crude into China has remained “healthy in January and February,” agrees Serena Huang, lead analyst at Vortexa, a London-headquartered ship tracker.
“Most of the crude arriving in China now was bought in November or December. Obviously, importers cannot simply declare force majeure on 10-11mn bl/d of crude arriving,” says Tom Reed, vice-president, China crude and products at price reporting agency Argus Media.
However, that is not to say that Covid-19 has had no impact on the Chinese oil market.
Monitoring the full picture of crude, storage and products movements, Booth’s view is that “ultimately, it is implying that overall crude runs are lower”. In other words, while China’s crude imports have remained robust, its refiners are processing less of it and putting the remainder in storage.
“Both the big state-owned [refiners] and the independents have taken the decision to really cut back on crude runs”, agrees Huang, given that jet and diesel/gasoil spreads have plunged in recent weeks.
Reed puts some big numbers on the trend. “We estimate that Chinese refinery runs [in February] are 4mn bl/d lower than they were in January,” he says, stressing that this figure is based on a survey of around 70 refineries in China, not on a GDP reversion model. “So, we are fairly confident about that number.”
“The big state-owned [refiners] and the independents have taken the decision to really cut back on crude runs” Huang, Vortexa
But he stresses that the Chinese refining picture is not uniform. Independent refineries in Shandong were among the first to cut crude runs, says Reed, as they are highly flexible and can adapt quickest to changing market conditions, Argus predicts that they are likely to run only half as much in February as in January, while many have brought forward maintenance in light of the drop in demand.
State-controlled Sinopec, the world's largest refiner by distillation capacity, has, in Reed’s view, been hardest hit geographically because it is most exposed to the loss of demand arising from transport restrictions in central China. It operates two refineries alone in Hubei province, the epicentre of the virus, where there is a ban on almost all road traffic until mid-March. Argus forecasts Sinopec’s throughputs will average 1.5mn bl/d lower in February than January.
Its peer PetroChina is also affected, says Reed, as Coronavirus incidents in late February saw a slight increase in northeast China, where PetroChina has a lot of refineries. It too will slash runs, by c.700,000bl/d in February. “These are massive run cuts, potentially signalling the lowest throughput rate in six years,” says Reed.
On the other hand, he does see evidence of green shoots in the northern Chinese refining market. “It is already starting to recover—we are starting to see fuel demand and refinery utilisation rates creep higher already in late February in Shanghai,” he says.
This reduction in refining output appears, though, insufficient to fully offset the loss of domestic demand, meaning more clean products exported out of China. “If you look at the comparative like-for-like periods before and after Chinese New Year through the last number of years, we have seen more of a sustained increase in exports following on from Chinese New Year 2020 versus 2019,” says Kpler’s Booth.
In further evidence of a Chinese industrial slowdown, Kpler has seen a significant drop in both LPG and, “to a lesser extent”, LNG imports. The former product is a key feedstock in the Chinese petrochemicals sector, so, again, this in particular points to reduced activity.
And, on a more macroeconomic level, the firm has also observed a “marked decrease from January to February” in China’s iron ore imports. Clearly, “the impact on economic activity from coronavirus” is playing a role in this change, says Booth, although he cautions that the impact on iron ore loadings from cyclones hitting Australia’s key Port Hedland export hub will also be feeding into that reduction.
Indeed, as a reminder that not every factor combines to paint the same picture, China’s coal imports month-to-date in February are actually materially higher than in January, a trend that Booth admits is “counter-intuitive”.
The oil market’s short-term future, as with the wider global economy, is so dependent on how Covid-19 plays out as to make concrete predictions almost meaningless. Clearly, if the virus becomes endemic across large swathes of the globe, then its destructiveness across all productive activities is difficult to model. However, if, as in the China experience, it can be contained, it may be possible to pick out some issues to look out for going forward.
One aspect is clearly whether China can continue to absorb as much crude as it has been so far. Vortexa has been monitoring loading programmes in the Mid-East Gulf, the main source for Chinese imports, with its data showing “loadings of Middle Eastern crude heading towards China have taken a hit over the past few weeks”.
“It may be beyond Chairman Xi's powers to prevent Chinese oil demand shrinking by 500,00bl/d this quarter” Reed, Argus
Huang advises that observers should keep a close eye on loadings from Saudi Arabia, Iraq and Oman, which are the key suppliers to China, for further evidence of this trend. But the earliest clear indicator might be Russia’s Espo, says Huang, as this is bought by the Chinese independent refiners on a spot basis, and therefore might be quickest to show reduced crude imports.
Reed predicts that Chinese buyers are “going to slash purchases from the April learning programs”. But he also flags that “major buyers, such as Sinopec, have already tried to resell or lift less cargos from the March loading programs”, suggesting that efforts to reduce Chinese crude imports are already underway.
Although China has vastly expanded its crude storage capacity over recent years, there will be limits to how much crude it can continue to bring in without refining it. And there is little chance that products storage will assist.
“Despite China's massive investment in crude storage capacity over the past decade, notably since the liberalisation of crude trade in 2015, there have been fewer incentives to build clean product storage tanks,” says Reed. “Independent refiners, for example, tend to try to refine only as much fuel as they can sell. So, China's clean storage capacity is fairly inadequate—it is probably about half of what its crude storage capacity is.”
The refining sector’s absorption capacity faces other challenges, not least, Booth points out, as we are heading into a maintenance season where refining capacity will be out of action even if an easing of the Covid-19 impact improves demand.
There are also significant questions over where refined products could go, even as and when China gets back to normal in terms of refinery runs. Its domestic demand will take time to rebound, even if stimulus both during and post-coronavirus could ultimately lead to a strong recovery.
And the rippling effect of the virus’ impact globally will depress the export market for Chinese products. This is already particularly apparent in the jet fuel market. Booth noted at IP Week that, as carriers cancelled Asian routes, they were looking to lay on more flights in and to other regions to try to utilise idle planes and pre-bought fuel supplies.
While it remains a fool’s errand to quantify the potential global impact of Covid-19, thoughts are beginning to turn to how China, which at least appears to have the outbreak under control, will rebound from its impact.
The Chinese administration’s efforts to shore up domestic demand have “actually been very impressive”, says Tom Reed, vice-president, China crude and products at price reporting agency Argus Media. Within days of the end of the Lunar New Year holiday, Beijing injected $170bn into the financial system, introduced tax cuts and has continually announced new stimulus measures.
c.80,000-90,000bl/d – Natixis’ Chinese oil growth prediction year-on-year
“I think China’s fiscal policy will very likely be countercyclical this year, despite relatively weak projected revenue growth for various provincial governments. 2020 is, after all, the year in which China aims to double its GDP relative to 2010 levels. That is very much at the back of the government's mind as it is a promise that they have made to the people,” says Reed.
“We do not know when the virus will be defeated and stop spreading. But we do know that additional government stimulus will be forthcoming. It may be beyond Chairman Xi's powers to prevent Chinese oil demand shrinking by 500,00bl/d this quarter. But we think we can predict, with a fair degree of certainty, a V-shaped recovery where demand bounces back in the third and fourth quarters this year as the virus is brought under control and those stimulus measures start to take effect.”
But Reed does have a caveat to his bullish scenario. Chinese refinery run cuts in February alone imply the loss of 120mn bl of oil demand, or 320,000bl/d over 2020 as a whole. Even if some of that demand is clawed back later in the year, he has concerns that “the market is not yet pricing in this massive crude overhang”.
Hancock is also more circumspect over the shape of China’s recovery. Although Natixis sees stimulus by the Chinese central bank resulting in a business-as-usual economic case by the second half of this year, physical oil logistics mean that it will take longer than that for oil flows and consumption patterns to return to normal. We will “probably look more towards the end of the third quarter or fourth quarter before we do have business-as-usual from a consumption standpoint”, says Joel Hancock, lead energy analyst at bank Natixis. "At present, we see China's year-on-year demand growth being c.80,000-90,000bl/d, when we were previously thinking more like 400,000-500,000bl/d.”
This is the first in a series of articles about the impact of Covid-19 on energy markets. The second can be found here.