Oil Prices and the Coronavirus Pandemic
Last month, the coronavirus outbreak took the world by storm, as the epidemic created in a food market in Wu Han City, China, plagued the lives of many across the globe. However, the victims’ lives are not all this virus has impacted, with the economy taking a hit too, most visible so far in the oil & gas sector. Oil slid into a bear market with a decline of an average of at least 15% from a recent peak. At the start of this Financial Year, oil was selling at USD 70 per barrel. The prices have plummeted to USD 55.
Why has coronavirus put such a dent in the prices of oil? The highly contagious nature of the virus render people wary of travel. This is especially true for international travel as a result of which the frequency of air travel in a given period reduces and so the demand for oil diminishes. It is a simple economic principle that prices fall when demand diminishes but supply does not. According to a variety of sources, demand is expected to drop by 200,000 barrels per day this year, with 900,000 barrels per day drop within the first three months. This is equivalent to a 1% drop in global oil consumption.
However, there is also a speculative element to the fall in oil prices. Whilst the reduction in international travel is significant, the market witnessed a large sale by investors of their shares in oil companies for fear that a fall in share prices, due to the reduction in demand for the commodity, would injure them financially. For this reason, the stock prices of some of the biggest oil companies have fallen drastically over the past five weeks, alongside the plummeting oil prices. Since 10 January, Shell’s stock price has fallen approximately 12.5%; Chevron’s stock price has fallen 6.4%; and Sinopec’s stock price has fallen 8.3%.
The falling share prices result from investors selling their holdings in oil futures and investing in “haven assets” like gold and government bonds, which generally lie immune to extreme volatility in the market. Hence, an inversely proportionate relationship can be expected between the price of oil futures and gold futures over the next few months.
The Coronavirus pandemic has already disrupted several economies worldwide. The Chinese Academy of Social Sciences, a government-backed think-tank, opines that the outbreak could push the China’s annual economic growth below 5.0% for the first 3 months of this year. With the US-China trade war already bearing an immense burden on the country’s economic growth, stunting it at 6.1% last year, this is not welcome news for China. With several Chinese cities having been shut down, factories idled and flights cancelled, the think-tank’s predictions are not unfounded.
Further, many Chinese buyers are trying to stop or reschedule shipments by declaring ‘force majeure’ or ‘hardship’, each pertaining to circumstances in which a commercial contract might be set aside. Claiming force majeure might prove significant for many reasons, including playing a part in stalling supply chains and contributing to an economic recession. Additionally, several legal questions are raised on whether the pandemic qualifies as a giving grounds for force majeure in China or under the doctrine of frustration in England and Wales under s.7 of the Sales of Goods Act 1979.
How can countries try to mitigate some of these ramifications on the market? Currently the world’s biggest oil producers have convened under the OPEC+ Joint Technical Committee to discuss cuts to oil production. This will help stabilise prices. The opinion, as it stands, is to cut production by 600,000 barrels a day. Bjornar Tonhaugen, Head of Oil Market Research at Rystad Energy opines that the Joint Technical Committee’s recommendation was reasonable. However, Saudi Arabia’s oil minister Abdulaziz bin Salman is clashing heads with Alexander Novak’s more cautious approach to instituting any drastic remedial measures. Russia wants more certainty about the nature of the coronavirus outbreak and its results on the market. Saudi Arabia, on the other hand, is very keen on cutting supply. Nonetheless, the Joint Technical Committee is not a decision making body and can only provide recommendations for the respective countries’ respective oil ministers to implement. Currently, a meeting between oil ministers of OPEC + is scheduled for early in March where the forthcoming policy will be further clarified.
Further, China’s central bank has also eased monetary policy to soften the blow. The People’s Bank of China has made liquidity injections of Rmb 1.2 trillion (USD 174 billion) in addition to reducing loan prime rates to increase equity. This will help keep the economy machinery oiled and functional. However, it cannot be said with much certainty whether these tactics will smooth out tensions stemming from the pandemic entirely. Many questions lie still answered - only time will tell.
