The ongoing spread of the new coronavirus has become one of the biggest threats to the global economy and financial markets.

The coronavirus (COVID-19) outbreak has already brought considerable human suffering and major economic disruption. In China, containment efforts have involved quarantines and widespread restrictions on labor mobility and travel, resulting in unplanned delays in restarting factories after the Lunar New Year holiday and sharp cutbacks in many service sector activities. These measures imply a sizeable output contraction whilst the effects of the outbreak persist. Subsequent outbreaks in other countries, including Korea, Italy, Spain, the United Kingdom, and the United State have also prompted containment measures such as quarantines and border closures, albeit on a smaller scale. The adverse consequences of these developments for other countries are significant, including the direct disruption to global supply chains, weaker final demand for imported goods and services, and the wider regional declines in international tourism and business travel. Risk aversion has increased in financial markets, with the US 10-year interest rate falling to a record low and equity prices declining sharply, commodity prices have dropped, and business and consumer confidence have turned down.

One important impact of the coronavirus outbreak on the downstream oil industry is that the price of crude oil has fallen significantly in a short time, taking billions off the stock prices of major oil and gas companies.

Coronavirus affects the oil market in two ways:

1-First, travel restrictions due to containment efforts limit the use of jet fuel, and supply chains slow and industrial activity declines as companies send workers home—meaning less oil and oil-based products are being used and produced. This has very direct effects on oil consumption and informs near-term calculations of real oil demand.

2-Second, the stock market reaction to the effect of the coronavirus on the global economy builds a projection of global oil demand over the long-term. As broader market sentiment about the health of the global economy declines, so do projections about the future oil demand curve, prompting flight away from oil and energy stocks and further drawing down prices.

 

Declining Crude oil market

On 6 March, “Opec +” (the 14 member states of the Organization of Oil Producing and Exporting Countries plus the world’s second-largest producer, Russia) discussed the possibility of cutting production and stabilizing the declining market.

“There was a proposal from Opec to cut Opec+ production by 1.5 million barrels per day (bpd) until the end of June this year,” says Francis Perrin, Chairman Energy Strategies and Policies in Paris.

“Russia refused, and there was no agreement.”

The immediate result was that prices declined by 8 percent.

But the big blow came on 8 March, when Saudi Aramco, the world’s largest oil company, unilaterally announced that it would increase its production by 1 million bpd from 12 to 13 million. The Saudis also announced a price cut of between 6 and 8$ per barrel.

 

Price war

“It was the beginning of a price war,” notes Perrin. Prices fell another 25 percent and have hovered since at around 30$ per barrel.

Moscow was quick to point out that it ‘could deal with 25-30$/barrel for a period of up to five or six years. But analysts are skeptical.

“Russia may well claim that it would survive for five years, but oil is a significant part of its revenue. So if it is only just getting production costs from the sale of its oil, then its national revenue is significantly impaired,” Perrin says.

Russia is currently the world’s second-largest oil producer. The US recently took the first position as a result of its increasing exploitation of shale oil. But this, says Perrin, is also America’s weak point.

“The US is increasingly producing non-conventional shale oil, that is costly to produce,” he points out, while Saudi Arabia enjoys the world’s lowest oil production costs.