Podcast: Coronavirus - a black swan event for the global crude market | Episode 1

Author Alejandro Babarjosa, Vice-President, Crude, Middle East and Asia-Pacific

The coronavirus epidemic’s effect on energy consumption in China, the world’s top crude importer, is unprecedented. About a third of the country’s total refining capacity is down at a time when oil markets were already oversupplied.

Economic activity remains subdued, making it uncertain how long the downturn will last. That’s already being reflected in the value of virtually every crude grade imported into Asia-Pacific. And there is also the question of whether Beijing will use this as an opportunity to consolidate China’s refining sector, contributing to the erosion of demand in the longer term.

Listen to: Coronavirus trickles down global oil markets – Episode 2

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Hello, everyone. My name is Alejandro Barbajosa, VP for Crude for the Middle East and Asia Pacific at Argus, and I would like to welcome you all to our latest podcast as we discuss the impact of coronavirus on the global crude market. The epidemic is nothing short of a black swan event for the global oil industry. Why is this the case? If we think about the size of recent disruptions to both production and demand in the global market, and we, for example, take the attack on Saudi crude infrastructure last September where about half of Saudi Arabia's production was brought down for about two weeks and we see the impact that that had on the market, we realize the cumulative effect of the current disruption to demand in the Chinese market is probably going to be much bigger as it will last for longer than that event back in September on the supply side.

We need to consider that the epidemic has forced the shutdown of a significant proportion of China's refining capacity. About a third of total refining capacity has been shut down from a total of about 14 million barrels per day of crude that were being processed every day before it started to less than 10 million barrels per day today. This means that crude processing in China now has dropped to its lowest level since 2014. Now, when we look at the facts, it's also important to look at the distribution of the cuts that we have seen across the different segments of that market of the refining sector in China and we see that the drop has been led by the independent refiners of Shandong and that drop itself has been of 1.8 million barrels per day. This has been the engine of the global oil market for the past few years and the moment that you take that demand away, you're obviously bound to have a deep effect in terms of the prices that we're seeing on the spot market for crudes around the world.

Let's start with the Middle East and let's take the case of Abu Dhabi Murban crude. It's now fallen to its deepest discount to the OSP since 2013, more than a six-year low. And that has been led precisely because Murban is a grade that is taken all across Asia and the fact that the third of the Chinese refining capacity is out of line, it means that those grades that normally would be going to China will have to be taken by other refiners that normally take Murban. Now, Murban competes directly with WTI crude imported from the U.S. in the northeast Asian market and it competes for market share. In fact, Argus data shows that for the past two years it's been consistently U.S crude that has been gaining market share in the Asian market as opposed to Middle Eastern grades, which have actually lost market share in Asia Pacific as a whole. Now, when we look at the price of delivered WTI to the northeast Asia market, which Argus started publishing on November 1st, we see that the price has dropped from a premium of about $7 or $8 to Dubai just a few weeks ago to half of that, around $3 or $4 per barrel premium to Dubai.

This is a very significant drop because, again, although China was not taking big volumes of U.S. crude before this demand disruption, this means that other countries that have been taking U.S. crude on a regular basis are going to start to absorb some of the volumes that are no longer taken by China. So, that direct competition between those different grades causes the weakness in the values of the U.S. crude that is being shipped to the northeast Asia market. And this has implications as well for the phase one trade agreement between China and the U.S. where there had been a serious commitment on the Chinese side to increase energy commodities from the U.S., in particular crude. At current prices, those commitments would imply that China would have to import about 1.2 million barrels per day of U.S. crude to meet those requirements. Now, under the current circumstances, when we see that about 4 million barrels per day of Chinese refining capacity are offline, it's going to be extremely difficult for China to meet those commitments.

So, we see that the implications of the demand drop from China are going well beyond the short-term and it may actually have a more structural impact on the ability of China to meet those increasing consumption requirements set by that phase one trade agreement with the U.S. The case of Russian crude is also quite interesting because ESPO crude, East Siberia Pacific Ocean pipeline crude, is focused on the Chinese market and we have seen that as cargoes from Kozmino have been already traded for loading in April, there has been a sharp drop in the differential over Dubai in the premium from about $6 per barrel to just $2 per barrel. It's the lowest level since late 2018, and that has been the case for most of the other grades that are regularly imported into the Chinese market. This also goes for those grades that are traded on a delivered basis into the Shandong market that Argus reports as DS or delivered ex-ship, Shandong, Lula, ESPO, Djeno, and Oman, which have fallen to their lowest levels in almost a year and we continue to see weakness across that market. That's one of the other structural implications that we need to consider, that if there is a more permanent effect on China's ability to import crude, there might be a trend of consolidation in the Chinese refining system that would probably initially affect the refiners in Shandong, which have been the ones that have been cutting runs or processing less crude, reducing processing rates at the fastest rate so far.

There's a lot that can happen in the meantime. We could see a recovery in demand that would take us back to refinery runs at the levels that we were seeing before the epidemic erupted, but there's no doubt that we're witnessing one of the most dramatic demand impacts in the global oil market over the past few decades, and that's why we label it a black swan event. Thank you, everyone, for listening and just to let everyone know that Argus has been publishing the latest news and analysis on this topic, which are available through our Argus crude services. You can also access a special page dedicated to the effects of the epidemic across all commodity markets on our Argus website. Thanks and all the best.

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