West Texas Intermediate crude oil prices have fallen 20% in 2020 as fears that Chinese oil demand will fall by two million barrels a day. The outlook is for the Chinese economy to experience contraction. The onset of the coronavirus has isolated China and the lack of transportation and manufacturing is expected to weigh on crude oil prices. OPEC has been quick to announce that they are going to reduce output to help buoy crude oil prices.
What has happened?
The coronavirus that started in Wuhan China has spread showing 20,000 cases have been confirmed worldwide. Some believe that hundreds of thousands may not yet have been diagnosed. The Wuhan coronavirus has now infected 20,438 in mainland China, with nearly 200 cases reported in other areas around the globe. There was a second human-to-human case was reported by the U.S. Centers for Disease Control. While the virus has spread outside of China, most of the concern with within the world’s second largest economy.
How will OPEC handle this decline in demand?
OPEC is now headed for another production cut of up to 1-million barrels a day to offset the potential 2-million barrels a day in reduced demand due to the coronavirus. OPEC technical experts are expected to meet to evaluate how the coronavirus is generating demand destruction. This could lead to an emergency ministerial meeting to decide on OPEC production.
Saudi Arabia has been the driving force behind a potential cut with the Kingdom circling the wagons. There are several different estimates of how this virus will alter oil demand. S&P Global Platts sees global oil demand falling by 2.6 million barrels a day in February and another 2 million barrels in March. China has already cut the size of its March orders from Saudi Arabia.
Hedge funds dump long positions
The quick acceleration of price action has led to a decline in long position in futures and options held by hedge fund traders. According to the latest commitment of trader’s report released for the date ending January 28, 2020, managed money reduced long position in futures and options by 30K contracts which was more than 10% of the total outstanding long positions held by managed money. During the past week hedge funds increased short position in futures and options by 26K contracts. Total open interest in the managed money category still shows that hedge funds are long more than 3-times the number of contracts they are short. Managed money is long more than 250K contracts of WTI crude oil compared to a short position of approximately 77K contracts. This is likely why there has been a continued liquidation pushing prices down more than 20% in 2020.
Take away
The underlying theme in the market is that the lack of economic demand for energy from China will weigh on prices. China is the second largest consumer of oil in the world, second only to the United States. China is also the worlds largest importer of crude oil. Canceled flights, closed international borders, and segregated cities are dragging on oil prices and investors are bracing for greater volatility ahead.
The decline in demand will come from the lack of transportation around the country as well as a dip in manufacturing. The number of cases of coronavirus is continuing to increase as authorities are attempting to contain the spread. Most of the cases are within China which is good from a containment standpoint. While oil prices might get a boost from an OPEC cut, until the virus is contained, prices will likely remain under pressure.
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