China loses its appetite: The impact of coronavirus
The novel coronavirus has restrained China's voracious hunger for oil, leaving Middle East producers with too much on their plate
After months of worries about crude oil supply being thwarted by geopolitics, the industry narrative has flipped, with the novel coronavirus outbreak in China sparking fears about demand. In reaction, oil prices spiralled as low as $53 per barrel of Brent crude, down from a 2020 high of $68 per barrel.
“The market response to the health crisis in China is highly reactionary in nature, given that it is not yet clear how deadly the disease will be and what the long-term impacts on the Chinese economy and commodities could be,” says John Bambridge, features and analysis editor at GlobalData.
At the epicentre of the outbreak is Wuhan, a transportation hub home to 11 million people in central China. As of writing, more than 100,000 people have been diagnosed with the coronavirus, and at least 4,000 are dead because of the illness, with the overwhelming majority in China. The existence of the coronavirus was first noticed by a Chinese doctor in late December 2019, and various reports have estimated that it will take a minimum of one year to develop a vaccine.
“The outbreak of the coronavirus in the Chinese city of Wuhan brought back memories of the SARS outbreak in China in 2003,” says Ole Hansen, head of commodity strategy at Saxo Bank. “Before being contained, it had killed hundreds and hit the Asian economies hard as business and consumer demand plummeted.” China has radically changed since the SARS outbreak, more than doubling its oil consumption—it has a much wider impact on the market now than it did in the early 2000s. The International Energy Agency (IEA) estimates that China was responsible for more than three-quarters of the growth in global oil demand in 2019.
“The timing could not have been any worse with the [coronavirus] outbreak occurring days before the beginning of the Chinese New Year, when hundreds of millions of workers travel home to visit their families. With several cities in lockdown and many events cancelled, the Chinese economy is likely to take an economic hit during the first quarter,” Hansen adds.
Chinese authorities have completely shut Wuhan off from the rest of the world, stopping planes and trains traveling outside of the city, and halting public transportation inside the city. At least 12 other cities in the Hubei Province have restricted travel—considering just Wuhan and two nearby cities, Huanggang and Ezhou, more than 19 million people have essentially been grounded in place. As the coronavirus spreads, more travel restrictions are being enacted in affected countries.
“When cities are placed under quarantine, and public transit is shut down, by definition that reduces economic activity and has a negative impact on energy demand, oil included,” John Freeman, a Raymond James analyst, says in a note to clients. “Once there is evidence that the outbreak is contained and thus economic disruption subsiding, sentiment on oil should improve, bringing prices back up.” But since it was declared a health emergency on 30 January, the coronavirus has spread to at least 35 other countries.
Chinese tourists are responsible for $277 billion worth of spending per year, according to the UN World Tourism Organisation, and with millions facing restricted travel during a major holiday, when fuel sales typically jolt, that means far fewer active trains, planes, buses, cars, and other vehicles—and far less fuel needed to power these vehicles. With many factories shut down and idle, it also means less energy needed to power industries. In any other country, this might not create a huge dent in oil demand. But China has a massive appetite for oil, and anything that happens in China has global repercussions.
China became the world’s largest oil importer in 2016, surpassing the US. In 2019, it imported a record breaking 506 million tonnes of crude oil, according to the General Administration of Customs. The increase is mainly due to growing demand from new plants which have, over time, added 900,000 barrels per day (bpd) of oil processing capacity.
Last year, it halved shipments from the US due to the trade war between the two nations, with no December imports recorded. However, as part of the phase one deal to end the dispute between the two countries, China pledged to buy a minimum of $52.4 billion worth of US energy products in the next two years. Research from Refinitiv showed that China continued to purchase a limited amount of Iranian oil after the US applied sanctions against Iran. In 2019, it imported approximately 14.77 million tonnes, half of the amount it imported in 2018.
In contrast, China is a major customer for Gulf oil producers, buying up around one fifth of their oil. Saudi Arabia is a particularly large supplier to China, with imports from the nation jolting by 47% in 2019, as Saudi Aramco expanded its Chinese customer base to include private refiners, not only state refiners. China bought 83.32 million tonnes of crude oil from Saudi Arabia in 2019, according to Reuters data, approximately 1.67 million barrels per day. In November 2019, Saudi Aramco signed crude oil sales agreements for 2020 with five Chinese customers, increasing total volume by 151,000 barrels per day compared to its 2019 supply contracts.
Outside of hydrocarbons, non-oil trade between the GCC and Beijing hit nearly $200 billion last year, and more than 1.6 million Chinese tourists visited the GCC in 2018, with UAE emirate Dubai as their primary destination. The coronavirus outbreak and subsequent travel restrictions could dampen those figures at a time when GCC nations are striving to reduce oil dependency. The International Monetary Fund in a February 2020 report said that without stronger diversification, Gulf economies could see approximately $2.5 trillion in accumulated wealth crumble away in 15 years as global oil demand drops.
“Fears about the coronavirus outbreak have weighed on oil prices and clouded the near-term outlook for the Gulf countries,” London-based research consultancy Capital Economics writes in a report. “Lower oil prices and a possible deepening of oil production cuts will act as a headwind to growth in early 2020.”
The potential impact of coronavirus on China’s demand for oil is uncertain. The IEA cut its 2020 growth forecast by 365,000 bpd to 825,000 bpd, the lowest since 2011. It also expects Chinese crude throughputs from the first quarter to drop by 1.1 million bpd, a 500,000 bpd contraction year on year. The US Energy Information Agency (EIA) has cut its global oil demand growth forecast for 2020 by 310,000 bpd due to the coronavirus-shaped dent in China’s oil consumption.
“EIA expects that travel restrictions in response to the coronavirus, along with the related economic slowdown in China, will reduce petroleum demand and keep crude oil prices below $60 per barrel through the first half of this year despite current disruptions to crude oil supply,” EIA Administrator Linda Capuano says. Despite Libya’s production slashed by an ongoing blockade to just over 120,000 bpd, down from 1.2 million bpd, US sanctions against Iran slowing the nation’s output to a crawl, and deeper cuts from the Organisation of Petroleum Exporting Countries (OPEC), growing fears of decreased demand from China are outweighing the impact of this drop in supply.
“Coming amid the shutdown of Libyan oil production and a fresh missile attack on the US embassy in Baghdad, the coronavirus-linked drop in oil prices illustrates the now perennial underweighting of Middle East risk,” Bambridge says. “Repeated incidents over the past 12 months have caused only brief spikes in the oil price, with little lasting impact. Despite the geopolitical situation, prices have remained depressed on the back of underlying assumptions about supply and demand conditions.”
OPEC forecasts a drop in global oil demand of 440,000 bpd in the first quarter of the year, and 230,000 bpd over the rest of the year. It makes sense for OPEC, a group of oil producers, to project confidence, but their reaction will have a sustained effect on both the oil price and market balance. Meanwhile, Bloomberg reports that Chinese oil demand has dropped by 3 million barrels per day (20% of its consumption) due to the coronavirus.
Its joint technical committee has advised OPEC to extend output cuts until the end of the second quarter, and reportedly suggested it cut an additional 600,000 bpd. OPEC and its allies (OPEC+) have decided not to convene for an early meeting, and will meet to discuss market shifts on 5 and 6 March. “Given the latest developments and crude oil’s inability to find support from geopolitical worries, the OPEC+ group will be forced to extend production cuts beyond March,” Hansen says. “Until either demand picks up or non-OPEC production fails to deliver the expected barrels.”
Russia seemed hesitant before the talks, with Energy Minister Alexander Novak saying in February that he needed more time to decide. “[We do] not fully understand the situation and clear forecasts for the development of events in connection with coronavirus,” Novak said. “To do this, more time is needed to see how the situation will develop, what [the] impact will be on world markets for oil.” Meanwhile, Oman’s Energy Minister Mohammed Al Rumhy has said that he would support a short, deeper cut through to the second quarter, and Iran’s Energy Minister Bijan Zangeneh said that he would support the decision. While Saudi Energy Minister Prince Abdulaziz bin Salman urged calm at the start of the outbreak, he recently likened it to a house on fire, saying that one could take a chance at putting it out with a fire hose, taking a measured approach but risking losing the entire house, or could call the fire brigade, potentially overreacting but ensuring the house remains intact.
OPEC+ failed to reach an agreement as Russia refused to make further cuts, to which Saudi Arabia responded by slashing its own crude prices and removing limits on its own production, sending oil prices crashing to $33 per barrel of Brent crude.
OPEC+ deepened its existing cuts in January 2020, with total cuts now amounting to 1.7 million bpd, as well as an additional 400,000 bpd shouldered by Saudi Arabia. “The declines, coming at a time of curtailed output, threaten economic shocks that, if long-lasting, could lead to the kind of political and regional instability that was avoided during the last steep drop,” says Ellen Wald, author of “Saudi Inc.”, in a commentary for Bloomberg. Unlike previous price shocks, when producers were pumping at capacity, they are now restraining output. “In the feared coronavirus scenario, producers such as Saudi Arabia, Russia and the United Arab Emirates would face low prices in conjunction with lower production,” Wald adds. “If the situation lasted long enough, economic instability could have political consequences.”
The outbreak is also impacting liquefied natural gas (LNG) demand, with the Independent Commodity Intelligence Service (ICIS) estimating a 2.9 million tonne drop in China’s LNG demand in 2020. It forecasts total China LNG demand for 2020 at 65.5 million tonnes, with 2021 imports expected to rise to 71.8 million tonnes. It notes that industrial, power generation, transport and commercial sectors in China will be the hardest hit by the virus. “China is forecast to import 3.1 million tonnes of LNG in February 2020, down 1.2 million tonnes from imports in February 2019,” ICIS writes in its forecast. “The impact of the Wuhan coronavirus is the main reason for the downward revision.”
Rystad Energy says that China’s LNG imports in January dropped 10% year on year, and the firm revised its Chinese LNG growth estimate down to 4.7%, compared to its previous estimate of a 10-13% increase year on year. “Given the strictest lockdowns of cities and factories, the Chinese government is trying by all means to end the outbreak as quickly as possible, so we see a speedy economic recovery later this year and a return to growth in LNG imports,” says Xi Nan, vice president for gas and power markets at Rystad Energy. “However, the growth rate is expected to be much lower than previously predicted, mainly due to the industrial sector. The largest gas consumer in China is undergoing a heavy hit.” He adds that the partial or complete removal of tariffs on imports of US LNG, as part of the US-China phase one deal, could add a more positive sentiment to the market.
It is too early to tell how the outbreak will play out, when it will end, and how it will impact the oil market and economy in the longer term. But its short-term impact on oil has emphasised the delicate balance between supply and demand, and how quickly it can be toppled when demand is threatened, despite market resilience in recent (and ongoing) supply woes.
“Beijing’s measures to curtail the spread of the virus will undoubtedly impact economic activity and growth in the short-term, but it is far more speculative to make assumptions about the longer-term impacts,” Bambridge says.
“What has been made overwhelmingly clear, however, is the degree to which oil prices are being driven by demand-side indicators, and the extent to which effects on the Chinese economy in particular are able to influence oil prices over and above destabilising events in the Middle East.”