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Opec+ talks failure highlights virus uncertainty

Uncertainties over the economic fallout of the coronavirus epidemic a harbinger of more short-term volatility

A freak pneumonia-causing coronavirus spreading out of China, Covid-19, has triggered record weekly declines in world markets and slashed global crude demand—but its impact is so difficult to gauge accurately that world powers are struggling to agree on the best policy tools to deal with the crisis. 

This appears to be the immediate takeaway from the meeting between Opec and Russia in Vienna on Friday, where producers failed to negotiate a new output cut in order to shore up declining oil prices.  

It is not just policymakers who do not see eye-to-eye with each other. Analysts also differ widely in their economic and energy projections. Investment bank Goldman Sachs, for example, sees Brent prices bottoming at $45/bl in April and the global annual demand declining by 150,000 bl/d, while rival Morgan Stanley expects a subdued demand growth of 500,000 bl/d in 2020. According to the February Oil Market report by the International Energy Agency, demand growth is forecast at 825,000 bl/d this year.

Many expect that Russia will yet come on board with proposals that will see an additional 1.5mn bl/d trimmed from global supply. Moscow’s pain threshold—the minimum price of oil below which Russia’s economy would hurt unacceptably—is about $42/bl, while Brent prices could decline to as low as $26/bl in the absence of an agreement, estimates the Washington-based consultancy Rapidan Energy. 

$42/bl Russia’s ‘pain threshold’ oil price

Alternatively, Saudi Arabia may proceed with the cuts unilaterally, perhaps bringing in a few regional allies, says Khaldoun Khelil, a senior energy expert at the Middle East Institute, a Washington-based think tank. Either way, some short-term pain is likely unavoidable. 

“I expect markets will react poorly as they did to the Fed [interest] rate cut [of 0.5pc on 3 March], as oil production cuts would help cement the perception of looming or in progress recession,” says Khelil. 

Even if cuts are implemented, many experts doubt whether a reduction of around 1.5mn bl/d would be sufficient to calm the markets in the short term, given that Chinese demand online is estimated to have declined by about a third, or 3-4mn bl/d, in recent weeks. Attesting to these fears, Brent futures had already declined to multi-year lows of less than $50/bl prior to the Friday meeting.  

There is also growing criticism of the tools most central banks and oil producers favour in times of oversupply; interest rate cuts and production cuts, respectively. Faced with a novel threat in an ever-more connected world, some experts caution, these measures may not be entirely relevant. 

“The economic problem is that inability to obtain one critical component can shut down an entire factory,” states financial analyst John Mauldin, the president of the Mauldin Economics consultancy, in a note. “Monetary policy tools just are not designed for this situation. All they can do is stimulate demand, and virus containment measures will make any such demand hard to fill. Fiscal stimulus might help but would also increase the already massive deficit.” 

A big part of the problem is that we do not have a very good model to understand the economic impact of the virus. Early on, analysts attempted to compare it to its deadlier cousin Sars—which caused a 2003 epidemic in China that slashed the country’s growth by about 1pc—and breathed a sigh of relief when health data emerged that Covid-19 is considerably milder. But while the 2003 epidemic was largely confined to China, today’s virus has spread to at least 96 countries, infecting more than 100,000 people, killing more than 3,000 and disrupting business networks across the globe.  

“I expect markets will react poorly as they did to the Fed [interest] rate cut [of 0.5pc on 3 March], as oil production cuts would help cement the perception of looming or in progress recession,” says Khelil.

Besides, China plays a far more prominent part in today’s interconnected global economy. At the end of last year, China accounted for 16.3pc of world GDP, up fourfold since 2003. Its share of global manufacturing had soared almost fivefold to 30.5pc, according to the UK-based consultancy IHS Markit, while its oil consumption had more than doubled from 5.6mn bl/d to 13.9mn bl/d. Even if its GDP growth is slowed only by c.0.5pc, as the latest forecast by the International Monetary Fund suggests, the overall impact on the global economy would be far more significant than that in 2003. 

Adding to the uncertainties on the demand side, there are geopolitical questions regarding supply, too. Most importantly, Libya’s output has fallen by about 1mn bl/d in recent weeks due to conflict—Russia being the main patron of one of the side of the conflict—and it is unclear if or when exports will resume. 

Many see a brighter future one day soon, when treatments for the virus emerge and the panic subdues; but until that happens, and the global powers iron out their differences, more volatility appears to be in store. 

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