At a time when the energy sector is weighed down by debt and reeling from low commodity prices, American energy producers are now bracing for the biggest demand shock to hit the markets in decades: the effects of the coronavirus outbreak in China and beyond.
The outbreak has already claimed more than 2,600 casualties and infected nearly 80,000 globally, including 3,000 medical staff in China.
While the outbreak may not sweep the globe as swine flu did in 2009, the fear of a global epidemic managed to shave 975 points off the Dow Monday morning, and experts seem to agree that the economic effects of the fallout are likely to be more severe.
UBS recently warned that it could drag global economic growth to near negative levels during the first quarter of the year and cause the worst growth slowdown since the 2008 crash.
The effects are already showing up in companies' guidance and market reactions, with Apple recently saying that revenue for the March quarter would fall below its initial estimate, citing a temporary hit to global phone supply.
There are indications that suggest the outbreak may be tapering off, with the daily number of new cases in China beginning to decline. However, researchers have warned that it could rebound once Chinese residents return to work and school, and what spooked the markets Monday was a spike in coronavirus cases outside China.
Here are the three energy sectors that are likely to be hardest hit by the coronavirus epidemic, and why:
#1 Oil, Grounded by Demand
Oil and natural gas prices have remained low for the past year and could remain that way with the biggest oil importer now grounded.
China, the world's top oil importer, bought 41.24 million tonnes of crude in 2019, equivalent to 10.04 million barrels per day (bpd). But just two months after the outbreak of the virus, Chinese oil demand is down sharply because of dwindling air travel, road transportation and manufacturing.
China consumes 13 of every 100 barrels of oil that the world produces, and global oil companies are likely to feel the heat to some extent. Bloomberg has reported that Chinese oil demand has dropped by about 3 million barrels a day, or ~20% of total consumption.
The drop marks the largest demand shock in the market since the global financial crisis that ended in 2009. It’s also the most sudden shock the market has suffered since the Sept. 11 attacks nearly two decades ago.
Energy analytics firm S&P Global Platts has warned that the virus could shave global oil demand by as much as 4 percent, or 4.1 million barrels a day, in February and an average daily fall in global demand of 290,000 to one million barrels.
Meanwhile, energy watchdog IEA has said oil demand is likely to fall by 435,000 b/d in 1Q 2020--the first quarterly contraction in more than 10 years--and lowered its 2020 growth forecast by 365,000 b/d to 825,000 b/d.
The EIA is a bit more sanguine and still expects West Texas Intermediate to remain above $50.00/bbl this year and average $55.71 in 2020.
Global demand for jet fuel has taken a big hit after a series of carriers suspended flights to China. Key international airlines that have cancelled or reduced flights to China include British Airways, Lufthansa, American Airlines, United Airlines, Austrian Airlines and Swiss International Air Lines. Other international airlines are also rapidly scaling back flights.
Jet crack spreads--a metric that measures the differential between an oil product and the crude from which it is derived--have already narrowed against Brent crude amid expectations of lower demand. Asian jet fuel refining margins have fallen to the lowest levels in over 10 years. More than 50 million people are affected by a travel lockdown in Hubei Province, the epicenter of the outbreak, slowing gasoline consumption.
Last week, some optimism returned to stock markets and oil prices briefly rallied when it appeared that new infections are slowing down. Unfortunately this was short-lived after China changed its methodology of counting the new cases leading to the numbers shooting up considerably and slowing the oil rally. While the negative effects of the epidemic on oil demand are not likely to last, the outbreak could damage the Chinese economy enough to lead to a more prolonged period of subdued demand and oil prices. Related: Are Americans Finally Sold On Soccer?
Whereas oil producers in places like Iraq and Saudi Arabia could see a 10% drop in profits, those in the United States could lose as much as 60% of their profits due to the much higher break-even price for the average oil well drilled in shale fields at roughly $45 a barrel. Most of the crude oil that China imports comes from Russia, Africa, Iran and other Persian Gulf nations, meaning producers in those regions are likely to feel the heat the most.
#2 Natural Gas, Already A Wreck
Natural gas prices recently tumbled to historical lows and are down nearly 15% since the start of 2020 with excess supply and inventory build up pressuring prices. The coronavirus outbreak is not helping the situation, either.
The global LNG leader Royal Dutch Shell has warned that the coronavirus outbreak is already hurting LNG demand and forcing it to reroute supplies previously earmarked for mainland China.
Yet, according to Ira Joseph, global head of power and gas analytics at S&P Global Platts, the coronavirus outbreak is not fundamentally changing the direction of the LNG market because it was already weak and heading in this direction. The coronavirus outbreak is seen acting more as a catalyst for this historic price collapse.
And the situation might not improve any time soon. Last year, RBC predicted that natural gas prices might take years to fully recover.
#3 Battery and Energy Storage
Last week, Utility Dive—which covers news and trends in the utility industry—warned that the coronavirus epidemic "... is going to be a very big deal" with respect to Chinese manufacturing.
Eight provinces in the country have already announced work stoppages as a result of the outbreak, which has negatively impacted multiple solar manufacturing campuses. This is highly significant considering that most of the world’s solar panels are made in China.
China also happens to be home to most of the world’s lithium-ion battery manufacturing. Utility Dive has warned that the country's battery storage production capacity could contract by 10%--or 26 GWh--compared to earlier forecasts.
On a more positive note, Utility Dive says a major disruption for the U.S. power sector isn't very likely since electricity generation comes from either domestic or non-Chinese sources, like coal, natural gas, renewable energy, and nuclear.
By Alex Kimani for Oilprice.com
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