Demand Destruction: The Coronavirus vs. the 2008/09 Financial Crisis.
Updated: Feb 23, 2020
The global economic slowdown in the wake of China’s coronavirus outbreak is set to reduce global oil demand in 2020 by up to 0.5%, BP’s Chief Financial Officer Brian Gilvary told Reuters on Tuesday. According to Gilvary, for the whole year, the slowdown will reduce consumption by 300,000 to 500,000 bpd.
As a result, prices and spreads across the complex have collapsed in reaction to the unexpected loss in demand. The question now becomes whether this is an opportunity to buy dips or whether we are facing a longer-term problem that could force markets into deeper contango. Will we have a V-shaped recovery (like the inverted V corrections we have seen after supply disruptions), or a U-shaped recovery?
Proponents of a V-shaped recovery expect:
- Once travel restrictions are lifted, floods of Chinese will resume travel for business and leisure, manufacturing will recover and pent-up demand will absorb any overhang
- Central banks in Asia-Pacific and the rest of the world could unveil a round of interest rate cuts in the next two quarters to offset the negative impact of the virus.
Proponents of a U-shaped recovery expect:
- A sharp drop in Chinese tourism will linger throughout the entire year
- The longer the China supply chain remains paralyzed, the greater the chance that manufacturing in Asia, Europe and the United States could grind to a halt because of shortages of components.
An interesting comparison has been posited by some market experts. Namely that the impact of the Coronavirus on demand could be comparable to that seen during the 2008/9 Financial Crisis. Since actual demand loss is unknown at this point, we look at past price action then vs now in the following chart. Specifically to compare continuous month 2 WTI futures (black line) to the continuous 12-month calendar spread (blue line).
Note that the 1-year calendar spread in blue (Month-2 vs Month 15) made it's first attempt to dip below $0 as flat price continued to collapse last week. Unless the V-recovery scenario gains some traction next week, calendar spreads like the one shown above have just begun their selloff. Meaning that further price moves may be larger in calendar spreads than in flat price.
Using another comparison to gain insight on what happens when the demand-side of the equation takes a significant hit, we look at EIA data for US Products Supplied as a proxy for demand. It's a difficult comparison to make at face value since high oil prices themselves contributed to demand destruction during the 08-09 crisis. Separate from price levels however, is real demand loss. We have yet to see the actual effects of the Coronavirus filter through EIA data. ALL EYES will be on the upcoming weekly EIA reports.
Outright WTI prices are close to where they bottomed-out during 2009, yet we are still waiting to see a corresponding reduction in demand data. It could be that products continue to be produced and the impact is initially seen via persistent builds in inventory. If this is happens, contango will have no choice but to increase as barrels bid for storage space.
The next 3 charts further highlight the inflection-point the market faces.
Calendar spreads, outright prices for the balance of 2020 and calendar strips are all flirting with 12-month lows. Headline updates regarding the Coronavirus and weekly EIA data have never been more critical pieces to the puzzle.
To get a sense of how the market is positioning as they await concrete data, we add commitment of trader data to the mix. Of the spreads that have collapsed in 2020, add the Brent/WTI spread to the picture. As this spread has narrowed (Brent losing it's premium to WTI), the net speculative positioning (money manager longs minus shorts) in Brent vs WTI has moved to a 2-year high.
As the Brent/WTI spread has narrowed, the net money manager open interest in Brent has increased relative to WTI. Separately, the net open interest positioning in each contract on both ICE and CME show a reduction in net length.
Part of the collapse in the spread can be attributed to reductions in tanker rates. Very large crude carrier (VLCC) rates on the busy Middle East Gulf to China route (TD3C) fell by 1.21 Worldscale (WS) points on Tuesday to WS 43.04, which worked out to time charter equivalent (TCE) of $16,865 per day, according to data from the Baltic exchange.
Freight on this route had jumped to WS 313.33 points on Oct. 11 at the height of the Cosco crisis in 2019.
Of the vessels on the water, force majeure clauses could lead to oil being stored on tankers. At current tanker rates, that would be a cost of approximately $.04/bbl/day. This would put much more pressure on 1-month calendar spreads as they now need to cover tanker storage costs. However with traditional storage capacity still available on-land, we don't expect this the market to move to price tanker storage for now.
Finally, US product prices have also been under pressure. Summer crack spreads in both gasoline and distillate are also approaching 12-month lows.
The expectation of summer seasonal demand lifting product prices is now less certain. Once again though, we haven't seen this lack of demand reflected convincingly in hard inventory data. If data emerges in the coming weeks that show product inventories piling up, oil prices will have no where to go but down.
The EIA inventory report for week ending January 31, 2020 reported a Total inventory BUILD of 3.40 million barrels with Crude oil making up the bulk of last week's build.
Year-to-date, this bring us to a Total Inventory build of 17.60 million barrels.
As mentioned earlier, Inventory LEVELS are going to be key going forward as both gasoline and distillate inventories remain slightly above those seen in recent years.
Lee Taylor - Technical Levels
Resistance: 54.21 – 54.25 / 55.93
Support: 52.99 / 50.22
Brent has effectively led the entire market down and the next big level of support is 52.99 then 50.22. The big moves in the market means that technical levels have greater distances between each other. There isn’t much resistance in April Brent after 54.21-54.25 until it gets up to 55.93. April/May and May/June Brent should make news lows again as flat prices continue bearish momentum.
Resistance: 50.55 – 50.93
Support: 49.22 / 47.00
The coronavirus is still the major headline affecting most of the world markets. One has to look at the weekly crude charts for some answers to support and resistance. The major weekly support level is now basis March WTI is 49.22 – the high from the last week in December of 2018. If the market breaches that level, then we will be looking for 47.00. Resistance is our old support level of 50.55 to 50.93. Plenty of resistance on the WTI spreads up front, but if we look at June/Dec WTI, look for support from .48 to .52. However, if that breaks, flat price will be moving towards $42.00 and this spread will be looking at -1.04.
Resistance: 1.5335 / 1.5402
Support: 1.4887 / 1.4664
March RBOB has been the lone bright spot in the energy complex. Although under major pressure like the rest of the complex, it was able to hold steady late last week. Resistance is now from 1.5335 up to 1.5402. One can find support in March RBOB at 1.4887 then 1.4664. Although HJ RBOB took many people by surprise, technically speaking, it performed well. Once it broke above -1708 on January 29th, it sold off right to the 50% retracement of -1749 then took off. Even last week, it held the -1708 level 3 straight days! In my opinion, this spread is overbought, and we should see a pullback to -1577.
Resistance: 1.6380 – 1.6536
Support: 1.6536 / 1.6179
We discussed a few weeks ago that we were nervous we could see a 20 cent move in flat price basis the weekly charts. Well, the heating oil market accomplished that; even flirted with another 20 cent move down to 1.4666. Let’s see how this week begins but resistance is now at 1.6380 then 1.6536. Support is 1.6273 then 1.6179. Once again, it appears that heating oil has been oversold. March/April heat will have major resistance above at 51.