Coronavirus: Panic becomes the reality

Author Zander Capozzola, Lead Deputy Editor

“Fear of the unknown is the greatest fear of all,” noted Yvon Chouinard the renowned American mountaineer and adventurer of the mid-20th century.

Chouinard was no stranger to the unknown, often venturing into unexplored terrain with little more than a sketch of a rock face or a single, grainy photograph of a mountain. Once surviving 31 days in a snow cave during a summit attempt, Chouinard's cautious approach to climbing showed it is possible to navigate the unknown with a margin of safety.

The rapid, global spread of coronavirus likewise has proved a dilemma for policymakers seeking to plot a clear path through what World Health Organization (WHO) director Tedros Adhanom Ghebreyesus described on 3 March as “uncharted territory.” 

With this frank admission, individuals, businesses, governments and market participants should pivot from attempting to divine models for how this unknown event will play out to instead appreciate that the crux of the current crisis lies in the market’s irrational responses to the myriad unknowns.

Coronavirus is all about potential — potential for rapid spread, potential mortality rates, potential macroeconomic fallout — and with so little known about the ultimate scale of this crisis, people will operate off of fear and emotion stoked by imperfect information. Gone are rational investors as the panic becomes the reality. This bodes for short-term volatility and requires businesses to operate in a highly fluid environment as coronavirus becomes the most mutable macro variable amid other strong competitors, including trade wars, petro-price wars, monetary policy and the election cycle, to name a few. It quickly becomes impossible to isolate the various effects on global energy markets as the crisis simultaneously precipitates a roiling global financial crisis.

The risks to the downside are considerable, particularly as the first deaths are reported across the US. Perhaps the greatest evidence of this is a rare inter-meeting Federal Reserve rate cut prompting some to wonder if the Fed knows something that the general public does not.

Understandably, analysts have tried to draw parallels to the most recent international health contagion — the 2002-2004 severe acute respiratory syndrome (SARS) outbreak. The SARS epidemic can provide a handful of useful, cautionary insights, but it hardly casts a perfect light on coronavirus’ potential. 

SARS, largely contained to China and Hong Kong, only spread to 29 countries in roughly nine months. It infected 8,096, killing 774. Its fatality rate was at 9.6pc. 

In contrast, coronavirus has reached 117 countries in just three months, killed 5,088 and has infected 137,387 as of 13 March. The coronavirus fatality rate is running near 3.7pc, according to data from John Hopkins University. Put another way, the global spread of coronavirus is already four times that of SARS, with nearly 17 times the infection rate and more than six times the number dead. SARS had an estimated R-zero rate — the number of infections resulting from one carrier — of four, while coronavirus has seen R-zero rates ranging from three to as high as six. 

The world, and China’s role within the global economy, has also changed drastically since 2002, further complicating a simple SARS/coronavirus comparison. The Chinese economy has grown nine-fold in the last 18 years, while its energy usage has more than doubled, making it the second largest oil consuming country. Air travel has grown by 47.5pc in the intervening years, increasing the potential international spread of the illness.

Coronavirus might be better compared to the 1918 Spanish flu outbreak, at least insofar as the speed with which it spread globally, as soldiers from the dozens of countries that fought in World War 1 returned from the brutality of trench warfare and were repatriated to their home countries. An estimated 50mn people died from Spanish flu, a tally coronavirus does not appear likely to match.     

Despite enormous medical advancements in the past century, it would seem that containment efforts such as travel restrictions, quarantines and protective medical suits, test kits and disinfectant are the only options on the table, as no vaccine currently exists.

So what insights does history provide?

For starters, we likely have not seen the worst of what coronavirus has to offer. During the outbreak of SARS and the Spanish Flu — both viruses affecting the respiratory system — an initial outbreak was later followed by a second, deadlier reacceleration. With less than three months of coronavirus data on hand, it's not yet clear what the virus' lifespan is like.

Coronavirus is likely to be a more drawn out event than the peak nine months in which SARS ravaged Asia. This implies that losses in financial and commodity markets will be more protracted with less pronounced recoveries like the one that followed SARS.

Most GDP forecasts currently circulating are conservative, with models containing the outbreak primarily to the Asia-Pacific region. The OECD’s more cautious projection trims half a percentage point off 2020 GDP to 2.4pc, while the organization’s projection of a 1.5pc GDP cut — should the virus prove more widespread and protracted — has received far less attention. 

The potential for a considerable outbreak in the US is also significant and could materialize very soon — and may have already occurred given the lack of widespread testing to date in the country. The implications for a widespread infection across the world’s largest economy are staggering.

While US employers and government officials are correctly heeding warnings and canceling unnecessary travel and conferences, many US workers, students and families remain poised to travel for spring break in the coming weeks. The US Transportation Security Administration said more than 108mn passengers flew during spring break last year, close to a third of the US population. Preliminary data showed strong US jet fuel demand in late-February of this year despite a slew of international cancellations. This suggests many US travelers are not cancelling their travel plans outright, but pivoting into other options deemed relatively safer. However, the US announced this week that it was initiating a travel ban for incoming Europeans this week which does not apply to the United Kingdom or US citizens.

The aviation and tourism industries are understandably bracing for heavy losses, where both first and second quarter demand is expected to be drastically cut. The airline industry association IATA expects aviation losses of $63bn-$113bn for 2020. A more pronounced outbreak across the US will erode road fuel demand as employers push workers into quarantine and work-from-home (WFH) options. Widespread school closures across the US should accelerate this dynamic. With most US refiners poised to return from seasonal turnaround maintenance during the second half of March, rising refined product supply will be met with falling demand.

Roughly 70pc of the US economy is service based. Some of these industries lend themselves better to WFH options than others. And some workers are simply unable to contribute to the economy if quarantined away from production locations. WFH could lead to a massive cut in the average worker’s gasoline expenditures. Diesel, meanwhile, could receive modest support as homebound workers turn to E-commerce options for consumer goods. 

Workers unable to work under quarantine will quickly require financial support with obvious implications for the US economy. While most governments of the world have little room to adjust monetary policy — the US included — fiscal policy will be the obvious stopgap to mitigate economic losses from a disruption of this magnitude. Countries without the ability to supply either could tip into recession.

A lack of global cooperation to rebalance crude markets has coupled with panic to cripple global energy markets. US crude prices plummeted to four-year lows of just over $31/bl on 9 March as Opec's plans to boost production combined with growing panic over the coronavirus spread.

The Russia-Saudi Arabia crude battle has muddied the waters, recalling the last big decline in crude four years ago. In 2016, high production and burgeoning inventories saw crude prices bottom out during the first quarter at $26/bl, requiring eventual Opec and non-Opec action later that year to bring a halt to further hemorrhaging. During this time the Gulf coast 3:2:1 crack spread as measured by Argus reached as low as $5/bl. But healthy export demand saw US refinery utilization only drop as low as 86.1pc, processing 15.5mn b/d of crude at its lowest point. 

By comparison, during the worst of the 2008-2009 financial crisis, refinery utilization sank as low as 66.7pc with crude runs reaching a nadir of 11.5mn b/d in September 2008 and WTI crude futures touching a low of under $34/bl by December 2008. Yet the Gulf coast crack spread was nearly three times higher during this period at just under $13/bl as domestic refined product demand hovered near a healthy 19.5mn b/d. 

The Argus Gulf coast 3:2:1 crack spread ended 12 March at $8/bl as widespread refinery maintenance and the transition to summer-specification gasoline prevented further losses. US refiners are currently operating a 86.9pc of capacity, yet much of the seasonal maintenance in scheduled to end within the next two weeks —although some are set to extend maintenance given the historic low-price environment. The scale of additional maintenance is currently unknown, yet some have pointed out it makes for better optics than outright run cuts at the moment. 

The global spread of coronavirus is likely to be a more protracted event with a greater economic impact than SARS as the world has gone through nearly two decades of globalization since the SARS pandemic. Given the size and interconnectedness of the US economy and the current appetite for travel, a wider outbreak in the US could materialize. As always, mature and efficient energy markets will balance out with production cuts countering any demand reductions. Yet the wider economic impact of loose monetary policy and fiscal policy could delay a broader economic recovery until late 2020-first quarter 2021, with some countries flirting with recession. Financial markets have seen repeated routs despite substantial injections by the Federal Reserve. An ultimate Fed rate to cut zero is anticipated.

For now, coronavirus will top the list as the most unpredictable variables facing businesses and policymakers. Wading into uncharted territory is highly unnerving, and following Chouinard’s example, best done cautiously, methodically and aided by the best equipment of the day. For the world’s energy markets, this more than ever means access to timely and accurate market intelligence.

 

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