Oil Sinks on Mounting Coronavirus Fears

The Chinese coronavirus isn’t just a public health crisis. It’s also a major threat to commodities markets, given that China is the world’s biggest consumer of most industrial materials. That’s especially true for oil, the price of which is sinking fast as fears of a possible pandemic mount.

At this point, it’s too soon to say just how serious the current outbreak will turn out to be. And thus, it’s too soon to know exactly how much it will affect global oil markets. But traders are clearly nervous. Benchmark West Texas Intermediate crude has fallen from about $58 per barrel last week to $53 now, as it became clearer that the mystery virus has spread faster than Chinese officials had previously admitted.

It’s not hard to see why oil prices are tanking. China is the world’s largest importer of crude and refined products. Its massive economy consumes about 14 million barrels of petroleum per day, according to the International Energy Agency. That puts China second only to the U.S., at roughly 20 million barrels per day. (And unlike China, the U.S. can largely meet its needs from domestic supply thanks to the fracking revolution.) What’s more, China is a major source of new demand in the global oil market. Last month, the IEA noted that developing economies are now driving global demand higher as mature economies start to burn less petroleum. China is at the forefront of that trend.

Bans on travel already cover more than 50 million people in China. If those restrictions spread, the hit to oil demand will get even worse. Meanwhile, there’s the risk that international air travel could suffer as more cases pop up outside China and other countries seek to keep out infected travelers. As of 2017, global jet fuel consumption accounted for nearly 7% of total oil demand, according to the Department of Energy.

Presumably, China isn’t going to shut down all internal travel. And international air travel isn’t coming to a complete halt. But any long-lasting drop in these sources of demand would likely be enough to measurably lower oil prices.

Not nearly enough is known at this point to forecast how prices will respond to the virus. But I think a few different scenarios can be sketched out. If authorities in China and elsewhere can get the disease under control quickly, the impact on oil demand should be modest and prices should rebound to their previous levels fairly quickly. If the number of infections and deaths continue to grow rapidly, demand figures to suffer badly, and WTI could sink below $50 per barrel. That would mean even more pain for energy companies already reeling from rock-bottom natural gas prices. A scenario somewhere in the middle, with infections spreading but not fast enough to trigger major travel and shipping shutdowns, would likely keep oil prices somewhat depressed. In that scenario, I would look for WTI to trade somewhere near $55 per barrel until the crisis passes.

In the longer term, I expect oil prices to gradually head higher. OPEC continues to limit its production, and there are rumors that the cartel will institute steeper cuts if Chinese oil demand shrinks significantly. Fighting in Libya has crimped that country’s production. Energy companies in the U.S. are cutting back on drilling new wells. And the recent armistice in the U.S.-China trade war should give the global economy a modest boost. All of those factors point to lower supply or stronger demand, which in turn should support prices. But until the specter of the coronavirus is removed, none of those factors is likely to matter.