Scapegoating Demand Destruction

Risk level: Orange

RED: Severe (+/- 4%) ORANGE: High (+/- 3%) YELLOW: Elevated (+/- 2%) BLUE: Guarded (+/- 1%)

THE BOOSTER SHOT

•           Demand concerns predate the coranovirus.

•           OPEC needs a Goldilocks moment.

Chinese refiners on Monday hinted they were cutting throughput amid demand concerns stemming from the outbreak of the Wuhan coronavirus. Fears of the spread of the novel coronavirus, 2019-nCoV, were blamed for the precipitous collapse in crude oil prices in January and those fears have turned into reality to some degree. According to the IMF, the outbreak is expected to put pressure on a Chinese economy already bruised by simmering trade tensions with the United States. The coronavirus has also attracted the attention of OPEC, though further restraints may not be warranted over the long term. First quarter decisions will certainly be impacted by the spread of the virus, though caution should be in vogue.

Demand concerns, both real and imagined, led to sharp sell offs in January, with Brent retreating further and further away from the $60 per barrel mark. The post-holiday malaise had already curbed the appetite for oil, and quarterly figures from some of the world’s biggest oil companies were disappointing. Brent closed the week down 4.2% to end at $58.16 per barrel.

Exxon Mobil last week reported first quarter earnings of $5.7 billion, down 5% from the same period last year. Annual revenue for 2019 was some 31% lower than the previous year. Output from the upstream segment, however, came in on the upside. The company is at the tip of the spear in getting oil out of Guyana and said fourth quarter liquids production was up 4% year-on-year, driven largely by output from the Permian basin in the United States. That production growth came during a fourth quarter that saw economic constraints emanating from the US-Chinese trade war, showing the market was already tilted toward the surplus. 

The demand destruction had already caught the attention of OPEC, whose members are meeting later in the week to consider their reaction to the coronavirus. The obligatory sources say Saudi Arabia may be coming to the table in Vienna with calls for big, but perhaps, temporary cuts to balance the market. But to pin the blame on the outbreak of the coronavirus is misguided. Demand constraints were an issue during the fourth quarter as the manufacturing sector in particular faced headwinds because of the trade war and the rising price for steel. By most accounts, manufacturing is in recession. In the shale belt, meanwhile, lower oil prices are taking a toll. Keith Phillips, an assistant vice president at the Federal Reserve Bank of Dallas, said the state’s economy will likely outpace the nation this year, but there were underlying concerns.

“The biggest downside risks to forecast are a sharp decline in oil prices, trade war escalation or a national recession,” he said.

It is easy to pin the blame on the coronavirus, though it is scapegoating to some degree. Dallas Fed concerns about recession predate the latest health concerns, though those concerns are making an impact, though the impact is to some degree emotional. Unlike a war on distant land, health concerns are related more directly to personal welfare. That can influence consumer behavior and compound the demand issues, particularly for fuels, as travelers stay home. Those, however, are short-term factors and do little to explain market malaise from the fourth quarter. Figures like GDP and segment employment are backward-looking indices, so are more reflective than predictive. Earnings reports offer something of a better view of the road ahead, and those reports have focused on more concrete concerns like trade. The IMF last week said that while there will be some economic issues stemming from the coronavirus, it is “too early really to quantify in any precise way the economic impact.” That sentiment should be considered by producers and corporations alike. Already, there are talks of sidelining as much as a million barrels per day in production in order to arrest the decline in the price of oil. Speaking to CNBC on Monday, Helima Croft, the head of commodities at RBC Capital Markets, said it is a “go big or go home moment” for OPEC. Any knee-jerk reaction, however, is risky, leaving the market vulnerable to mistakes. Too big, and the market pressure could disrupt economic growth even further. Too little, and OPEC looks blasé or even irrelevant. What’s necessary in the current market is a Goldilocks moment where cooler heads prevail.

We are still in earnings season, so pay attention this week to sentiments from the likes of BP. The Iowa Caucasus will also impact the market, particularly if left-leaning Bernie Sanders or Elizabeth Warren pass former Vice President Joe Biden. The reading on US manufacturing on Monday will certainly factor into the trading day, particularly if it misses. Construction spending is already expected to show a contraction. ADP payrolls for January are out on Wednesday, as is the usual EIA data. OPEC meetings later in the week, however, will be the main factor to watch. A cut of some sort is expected, so another Orange alert is in force for the week, with Brent expected to swing by at least +/- 3%.