The coronavirus (Covid-19) is upending two fundamental tenets of globalization: flow of people and goods and a booming Chinese economy. With nearly 1.5 billion people, and as the world’s largest economy, center of global supply chains, and largest emitter of carbon, it is safe to say that as China goes, so goes the world’s health, wealth, and, of course, oil markets.
Chinese oil demand has already dropped significantly. The International Energy Agency (IEA) forecast that global demand would decline in Q1 2020 for the first time since Q1 2009. With the movement of Chinese residents restricted, economic activity has slowed. Tankers laden with oil and gas remain moored outside Chinese and other ports. Estimates vary about how much oil will be taken off the market, with Goldman Sachs suggesting a peak daily loss of 4 million barrels per day (bpd). On the year, this would translate into 500,000 (bpd), or a 0.5% decline in global consumption.
Predictions by Chinese officials and Wall Street analysts that demand will return to the status quo ante when the epidemic ends this summer sound overly optimistic. Black swan events such as the 2008 global financial crisis (GFC) always have unforeseen, long-lasting consequences. At the very least, people are going to travel a lot less in the coming years, but the crisis could wreck serious, enduring damage to the Chinese economy.
Given where we are in the current cycle of a buyer’s market and the geopolitical and environmental forces bearing down on oil and China, the virus could in fact be a tipping point towards a new plateau in global demand, one that arrives earlier than expected, especially if the Chinese economy itself were to spiral into recession.
Demand shocks and market cycles
Oil operates, broadly, in long cycles of buyer’s and seller’s markets. Low prices and abundant supplies characterize the former, higher prices and scarce supplies the latter. During seller’s markets, companies invest in new discoveries, leading to overproduction and the next buyer’s market.
We have rotated between cycles of abundance and scarcity roughly every 13 to 18 years, since oil became the dominant energy source in the 1950s. Abundant supplies from 1952 to 1970 allowed Western Europe and Japan to rebuild their war-torn economies. Scarce supplies thereafter helped producers reap massive profits until price bottomed out in 1986. Another buyer’s market then prevailed until 2001, punctuated by the 1997 Asian financial crisis (AFC). Thereafter, China’s seemingly insatiable thirst for oil fueled the world’s most sustained seller’s market until 2014.
Many look to the GFC to understand today’s events. Yet the AFC, followed by Russia’s default on sovereign debt in 1998, offers better insights into how demand shocks operate in buyer’s markets. The demand shock teased out over 18 months, causing price to collapse to as low as $6 per barrel for some grades. This prompted a wave of industry consolidation, with major international companies joining together, for example ExxonMobil.
The current buyer’s market was built on Chinese demand. Its sustained decline or even plateau would profoundly rewire the global energy regime. At the very least, the coronavirus-induced demand shock will ensure that this buyer’s market endures.
Losers and winners
One such group that will clearly struggle is OPEC+. Already pushed to make cuts to contend with U.S. shale and new Western Hemisphere production in 2019, Russia and its oil-producing friends mustered enough political will to maintain a 600,000-bpd production cut last November. Coronavirus has essentially nullified this. OPEC crumbled under such market stress in 1986 and again in 1998. OPEC+ holds greater market share than during those days. But these dynamics will test the alliance, as more cuts will be needed.
The coronavirus will also likely push Russia and China even closer together, since their contracts are solidified and the mode of transit is fixed in the form of pipelines. Pipelines have an additional advantage: they do not, as most tankers do, require oil to run. Still, China’s smaller market share will leave less room for Russia, let alone room for new imports of oil and gas from the United States, which were promised as part of January’s trade truce.
The biggest winner from the coronavirus-induced demand shock is, of course, the environment. Any respite from steadily growing oil demand, let alone any type of plateau, means significantly less carbon in the air. Last week, the IEA announced that global carbon emissions did not change from 2018 to 2019. Coronavirus should make this a two-year trend, if not a drop in global emissions in 2020. Lower demand for oil in China, moreover, means fewer investments in oil and gas and thus reduces lock-in.
Every crisis is an opportunity
Events such as the coronavirus change societies and how their economies operate. It is a blow to globalization and its believers. I am reticent to believe those predicting a swift return to business as usual, especially authorities in a closed society. The world knows it depends on China for its health, wealth, and oil demand. It seems to be burying its head in the sand about what is ahead.
Even if the two-month epidemic is miraculously controlled and China returns to the market in force, oil is nevertheless wounded. People will initiate short-term changes in how they use energy during this period, which could become permanent. The energy transition, moreover, already means oil’s days numbered. Now is the time for governments to step on oil’s throat, so to speak, rather than lapse into buying more of it because of lower prices.
Photo credit: Pxhere.