Podcast - Coronavirus trickles down global oil markets | Episode 2

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

Economic activity has significantly slowed across Asia, denting energy consumption and oil demand, particularly in the transportation sector.

Travel restrictions and precautionary behaviour are curtailing people movement, sending oil prices to their lowest in more than a year. The implications are stark for the energy industry and for the people who work in it. And demand is likely to remain depressed as the epidemic expands to South Korea and potentially to other major regional economies, which have been forced to pare output.

Coronavirus: a black swan event for the global crude market – Episode 1

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Hello, everyone. I am Alejandro Barbajosa, Vice President for Crude in Asia Pacific and the Middle East at Argus, and I would like to welcome you all to the second episode of our coronavirus podcast series, where we discuss the impact of the epidemic on global oil markets. Today, we will broaden the topic to understand how the disruption triggered by the disease is trickling down freight and products markets. Economic activity has significantly slowed across Asia, denting energy consumption and oil demand, particularly in the transportation sector. To grasp the magnitude of the current deceleration, let's have a closer look at a key indicator for trade. The Baltic Dry Index, a standard measurement for global shipping costs, has slipped from more than 2,500 points 6 months ago to less than 500 last week. Talk of global trade seizing up maybe an overstatement at this point, but the implications of the epidemic on the flow of components and finished goods are palpable, as companies across different sectors struggle to maintain their usual supply chains.

Travel restrictions and precautionary behavior are curtailing people-movement, eroding fuel consumptions across Asia. Over the Lunar New Year period, Chinese nationals cut travel in half, including domestic and international trips, forcing some of the country's airlines to cut up to 80pc of their capacity, leading to unexpected 47pc drop in jet fuel use over the first quarter. This week, Singapore Airlines was among international carriers which announced capacity cuts across their entire network, canceling flights that account for more than 7pc of the southeast Asian airlines' total capacity through May. No wonder why we have seen Asian fuel oil cracks being battered to their narrowest in a decade. The premium of Singapore jet kerosene swaps over Dubai crude swaps fell to just above $8 per barrel this week down from more than $15 per barrel at the start of the year, according to Argus data. This means the profitability of making aviation fuel in the region is now at the lowest level since the aftermath of the 2008 financial crisis when markets were recovering from a multi-year global downturn in consumption.

The implications are stark for demand across all fuel categories in China. CNPC, China's largest oil company, expects that the virus will slash the country's oil use by 36pc in the first quarter from a year earlier. Anecdotal evidence already shows that over the New Year holiday period, gasoline sales shrank by 50pc or 60pc from January and in some places, they contracted as much as 80pc. CNPC expects diesel will lead the demand recovery if the epidemic comes under control in March, while gasoline and jet fuel consumption will only recover by June. Crude prices have reacted sharply, including ICE Brent's drop to its lowest since late 2018 and NYMEX WTI's first close below $49 per barrel in more than 13 months earlier this week. And it's very interesting to focus on the effect that the current demand slump is having on the forward curves for different benchmarks, which reflect future crude prices. The front-month ICE Brent contract had recently been at a discount relative to the second month, as the outlook for demand in the shorter term remains depressed by the epidemic.

However, a potential further reduction in OPEC crude production to counter the demand slump has recently helped ICE Brent recover a so-called backwardated structure, where prompt crude is commanding a small premium relative to supplies further into the future. But the outlook for Middle Eastern grades priced against the Dubai benchmark remains bleak. Prompt Dubai swaps this week traded at their deepest discount to contracts further forward since mid-2017, reflecting the weakness across Asia-Pacific crude markets. As an example, Iraq's SOMO has so far refrained from offering Basra crude cargoes through tenders this month as the uncertainty about any demand recovery undermines their ability to sell the grade at a premium relative to the Asia Pacific formula price. Contributing to expectations of an oversupplied market in northeast Asia, in April, Russia plans to export the biggest monthly volume of ESPO or East Siberia Pacific Ocean crude, in six months.

This means Asian crude markets still have a long way to go before they can rebalance following the China-led consumption drop of the past two months. And demand is likely to remain depressed as the epidemic expands to South Korea and potentially to other major regional economies, which have been forced to pare activity. Last but not least, the epidemic is also affecting the everyday life of people in the oil industry. Chevron this week ordered their London staff to work from home as the company awaits coronavirus test results for a staff member. As I have mentioned before, you can access more timely news and analysis on this topic through our Argus crude market services. And we also have a special page dedicated to the effects of coronavirus across all commodity markets on our Argus website at www.argusmedia.com/coronavirus. Thank you for listening and goodbye.

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