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Published on 24/01/2020 5:47:48 PM | Source: Motilal Oswal Services Ltd

The next three weeks will be crucial for the crude oil markets - Motilal Oswal

Posted in Commodities Reports| #Commodity Tips #Motilal Oswal

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Corona virus: The new virus in Oil Markets!

Highlights:

* Wuhan city suspends all public transportation services, shuts airport

* China Q1 jet fuel demand growth may slow to 3% from 7%-8% average

* Hong Kong's jet fuel imports fell 37% on year at height of SARS

* China add 9 cities to transportation ban, 32 Million people now impacted

 

Oil is bearing the brunt of anxiety and slid to 11 months low over concerns related to spread of Corona virus from China ahead of the Lunar New year holidays, the biggest human migration in the world. It is currently spreading to places like U.K, U.S. and Taiwan, but the question to ponder was how this social crisis brought a huge sell off in Crude oil. The answer was the by-product of crude i.e. Jet fuel which will get impacted by lower demand if it stunts economic growth in China and let’s not forget the fact that China is largest consumer for Crude oil. Oil markets have always been obsessed with Chinese economy as Chinese oil demand is growing by 5.5% p.a at 13.5Mbpd in 2018. At least 17 people have died and almost 600 have been sickened. China also had to isolate Huanggang city, a city with a population of 7.5 million people.

With Wuhan and now Huanggang city on lockdown, the fear is that food and medical supplies will become thin and that we could see more travel bans throughout China. Remember, Wuhan is the largest city in central China and major transportation hub. Officials in China have linked the initial infections to a Wuhan seafood and wildlife market, which has been closed since January 1 to prevent further spread of the illness. The spread of virus comes ahead of Lunar New Year celebration, which begins on Jan. 25 and can last through to the Feb. 8 Lantern Festival. It’s a significant travel period for the Chinese, raising the potential for further spread of the illness. The oil markets suffered the whole year with common theme of global demand slowdown but this months, investors had some expectation for the demand to boost as Lunar new year holiday in China is normally a boom for travel industry when gasoline and jet fuel consumption typically spikes.

More than 90 million people are estimated to move more than 100 km during this period by road, railways or air each day. The perception or fear to catch the virus, markets will see immediate reaction of people stopping travelling to some extent. This is enough to bring economic slump and create ripples in world economy as people change travelling, purchasing and trading patterns.

Demand:

The potential for a pandemic has stirred memories of the Sudden Acute Respiratory Syndrome (SARS) outbreak in 2002-03 started in China caused a slump in travel. For Coronavirus, it is estimated for virus to impact into 2020 volumes, leading to slowdown of 260,000 Bpd, including a 170,000 Bpd of jet fuel demand. But in disaster scenario, if it turns as contagious as SARS 2003, Global jet fuel demand will fall by 6,50,000-7,00,000 bpd for about 6 months.

 

“The question isn’t whether the virus will deepen the oil demand, rather, the question is how much it will depress the oil demand”

Considering series of travel and transportation restrictions, the country's overall oil product consumption could slip between 2% and 8% on year over Jan-Feb this year. China demand for fuel in May 2003 dropped around 35% on the year to 131,000 b/d in May 2003, a period for SARS epidemic. Along with China, several major cities could register a fall in demand for aviation fuel. Hong Kong experienced city's jet fuel imports tumble in Q2 2003, a period during which death toll peaked. The city imported 719,736 mt of jet fuel in Q2 2003, down 37.1%. SARS outbreak reduced annual traffic of Asian airlines by 8% in 2003 and Jet Fuel can take major hit as authorities cancel the flights in and out of Wuhun City.

China's demand for jet fuel rose 7.3% YoY to 898,000 b/d during the Q1 2019. However, the YoY demand growth for the fuel would slow to 3% in Q1 this year if the coronavirus persists till May, a significant slowdown compared to the average growth rate of around 7%-8% seen in previous years. The other by product of crude: Gasoline will experience YoY decline in Q1 as Wuhan city, located in the central Hubei province which is considered one of the major transportation hubs along the Changjiang River. In this situation, driving activities will slowdown in main hubs like Beijing, Shenzhen and Shanghai where road traffic flow usually peaks in Q1 in festive period in China.

 

Outlook:

The development over the next three weeks will be crucial for the crude oil markets as this has still not turned into epidemic. Once there is evidence that the outbreak is contained and thus the economic disruption is coming to an end, sentiment on oil should improve, bringing prices back up. But, if the number of cases getting infected increases, we might see further sell off in global markets. We expect prices recovering like we experienced in 2003 when prices were down nearly 20% at its trough during that epidemic, but the elevated level of fear ultimately subsided when pace of new cases reported slowed, with a total duration of the epidemic outbreak of approximately 5 months, before a quick recovery in regional activity.

On Long term perspective, we expect prices to remain under pressure in first half of next year, due to a forecast increase in global oil inventories. Prices are expected to rise in second half of next year due to forecasted global oil inventory draws and demand growth on back of modest acceleration of global economic growth. However, any marginal recovery in demand as a consequence will prove insufficient to propel prices higher in light of sharp acceleration in global supply growth. We continue to believe from a demand point of view that NYMEX WTI should lower towards US$52/bbl over the course of this quarter, but risk remain as geopolitical premium might push crude prices higher on account of retaliation from Iran which might bring disruption for Crude supply and prices can rally towards US$56/bbl.

 

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