Perhaps buoyed by speculation that oil demand in China is set to plunge as much as 20% if not more on the coronavirus "demand shock", on Tuesday OPEC slashed it forecast for global oil demand by almost a quarter million barrels per day as the coronavirus pandemic cripples fuel use in China, leaving the cartel facing a renewed glut despite its recent production cuts.
The cartel reduced projections for demand growth in the first quarter by 440,000 barrels a day, or about a third, in its monthly report, and 230,000 for the full year, one day after oil prices sank to a one-year low on Monday as the infection has idled thousand of businesses and left millions quarantined in the world’s biggest crude importer.
The plunge in oil prices has sparked a push by OPEC's top exporter, Saudi Arabia, to push for an emergency meeting and consider new output cutbacks, following a recent Vienna meeting that ended without a consensus after Russia - the biggest non-OPEC producer - refused to comply with further cuts as it is able to weather lower prices more easily.
Ominously for Riyadh, the latest OPEC report showed that, even though many OPEC members made a strong start with fresh output curbs that took effect last month, the overhang from the virus will leave them with an even greater surplus. The group collectively pumped 28.86 million barrels a day in January, down 509,000 on the month, and if it maintains that rate there will be a surplus of 570,000 barrels a day during the second quarter, when consumption slows down seasonally.
Furthermore, unlike bullish stock traders, OPEC doesn’t see the effects of the disease confined to the start of the year, and has cut its growth estimate for global oil demand in 2020 as a whole by a whopping 230,000 barrels a day to just under 1 million a day. Yet even with the cut, the increase remains slightly higher than last year’s. Related: Can Argentina Revitalize Its Oil Industry?
Ironically, despite OPEC's fatalism, oil prices recovered overnight precisely on the opposite, namely speculation the spread of the disease could be nearing its peak. Even so, Brent trading at $55 a barrel is well below the levels most OPEC members need to cover government spending.
It could have been even worse: since OPEC formed an alliance with non-members such as Russia three years ago, the coalition has restrained supplies to offset a surge of production from the U.S. shale industry, and keep prices supported, indirectly supporting the US shale sector. In January, OPEC launched a new round of cutbacks which served to briefly send oil prices higher before a bear market ensued in the days following on the coronavirus epidemic.
Last week an OPEC+ expert committee recommended reducing output by a further 600,000 barrels a day to offset the impact of the coronavirus. Russia, which held out, said it was “studying” the proposal and its energy minister, Alexander Novak, is consulting with oil companies today. Which may explain the latest gloomy OPEC outlook, which may encourage them to give greater consideration to taking additional measures.
“Clearly, the ongoing developments in China require continuous monitoring and assessment to gauge the implications,” the report said.
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The current frenzy in the global oil market will soon evaporate amid growing indications that the spread of the coronavirus outbreak could be nearing its peak. Once the outbreak has been contained, China’s oil imports and oil prices will rebound and recoup all their recent losses.
Still, any new cuts by OPEC or deepening production cuts by further 600,000 barrels a day (b/d) will be a total waste and futile with no effect whatsoever on oil prices and will only lead to a loss of market share.
Even if OPEC’s production plunges by 2.0 mbd on top of Libya’s virtual loss of its production amounting to 1.0 mbd, this will not stop the continued decline in global oil demand and prices as long as the outbreak is still raging. This is not due to lack of global demand but to physical inability of China to import and receive crude oil while it is in quarantine.
Russia is yet to be persuaded by the need for new cuts. Russia’s economy could live with oil prices at $40 or even less. There is another major reason why Russia is hesitant about new production cuts. Russian oil companies have long balked at continued production cuts, arguing that the cuts hinder their production expansion plans, while leading to a wasteful loss of market share.
Even with OPEC slashing 230,000 b/d from global demand growth for the full year, global oil consumption will still grow by 1.0 million barrels a day (mbd) to 102 mbd in 2020.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London