Simultaneous demand and supply shocks rock oil industry

• DOI: http://doi.org/10.1111/oet.12765
• Published date: 01 April 2020
• Date: 01 April 2020

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Simultaneous demand and supply shocks rock oil industry

As the spread of the COVID-19 corona virus continues

around the world, it remains unclear how severe the

impact on demand will be. But so far, each week that

passes has seen the likely impact grow, with over a third

of the world's population under some form of lockdown

by end-March.

For a start, the majority of the 8 mn bpd global jet

fuel market has disappeared, as most commercial flights

are grounded (95% in UK on 30 March, for example). The

impact on gasoline, with a market closer to 30 mn bpd,

will take longer to be felt, but the quarantines and other

travel restrictions are likely to cut demand substantially

(activity levels in many parts of Europe are below 10% of

normal levels). Diesel will be hit by lower industrial

demand, although heating (where residential demand is

up) is suffering far less. In total, a reduction in demand of

about 10 to 20 mn bpd

1

(10%-20% of total world demand)

looked likely at the end of March for a few weeks at least,

and below normal levels for some time after that.

This will completely overshadow the break-up of the

OPEC-plus group and subsequent moves toward a war

for market share on the part of Saudi Arabia and Russia

(on 6 March, Russia refused to back Saudi Arabia's pro-

posal for a deeper oil production cut, effectively firing the

first shot in what looked like being an expensive and pro-

longed battle for market share)—although, if it con-

tinues, the unrestricted OPEC-plus output may prolong

the oversupply situation as countries begin to return to

more normal levels of demand.

Brent dropped below $25/bbl mid-March, its lowest

level since 2003, and then dropped further toward $20/

bbl at the end of the month as the market faced one of

the largest supply surpluses on record. Citigroup esti-

mated (mid-March) that for 2020 as a whole, the oil sur-

plus could be between 1.27 and 2.73 bn bbl. The upper

estimate is looking increasingly likely, and if Saudi and

Russian taps are turned on, storage will simply fill up

even more quickly while freight rates soar (see below).

Once storage is full, any thoughts of a scramble for

market share would quickly have to switch to output

restrictions and shut-ins. In such a situation, demand is

more important than supply and there would be little

point in continuing to pump unless customers are lined

up. Possible import restrictions and support for domestic

producers among big consumers such as the United

States—either as part of corona virus business support or

to defend domestic industry—could provide support for

some companies. If a large amount of production is shut-

in, it may be difficult to reverse quickly, which could lead

to a rebound in prices once demand recovers.

1|DEMAND FALLS, REFINERS

HESITATE

The virus is destroying demand in many areas. The latest

(mid-March) International Energy Agency estimate was

for oil demand to contract in 2020 for the first time since

2009. It cut its annual forecast by almost 1 mn bpd and

that the market would now contract by 90 000 bpd—

however, by 27 March, this already looked out of date,

with far larger decreases likely this year.

The initial impact in China was in February, which

saw a fall of about 3 to 4 mn bpd (25%), although that

now appears to be easing. The size of the falls in Europe

and the United States are likely to be bigger, because of

much wider geographical areas have been disrupted and

locked down.

China's crude runs responded by falling 4 mn bpd in

February. In Europe, demand also began to fall signifi-

cantly in March, although refiners have been relatively

slow to respond, partly due to improved margins as crude

fell sharply in early March. But by the end of the month,

cuts were being implemented as margins turned negative,

along with a reduction in imports. Mediterranean

refiners saw the biggest margin reductions, reflecting the

severity of the virus/restrictions in Italy and Spain, with

some regional refineries cutting runs to around 20% to

30% capacity. Other European refiners are delaying

planned work in an effort to slow the spread of the virus,

while some are facing tough times financially, including

credit downgrades.

The United States and Canada are also seeing increas-

ingly tight travel restrictions and advisories—putting the

massive summer US gasoline market at risk. But, as of

the end of March, refiners had only dropped runs by

about 250 000 bpd from normal levels (see Table 1).

Between them, the United States and Europe account for

about 30% of the world's oil demand, with other countries

facing restrictions (including India and South Africa,

DOI: 10.1111/oet.12765

Oil and Energy Trends. 2020;45:3–12. wileyonlinelibrary.com/journal/oet © 2020 John Wiley & Sons Ltd 3