Whenever you talk about a deadly event like the coronavirus, you have to show respect to the human side of the story. At the same time, you also have to think about the financial and economic side.
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Ground zero for the outbreak of the virus may be the Chinese city of Wuhan, but financially, Ground zero is oil.
TickerSecurityLastChangeChange %USOUNITED STATES OIL FUND L.P.10.79-0.29-2.62%
Oil prices, specifically Nymex crude, are on track to have their most significant one-month net and percentage decline since the week ending November 30, 2018, as tracked by Dow Jones Market Data Group.
The reason oil is being hit hard is because demand is the first thing that gets destroyed in this situation. Demand destruction is a permanent loss of oil demand due to unexpected events. So far, the coronavirus is creating oil demand destruction on a massive scale. This could turn out to be the most significant demand destruction event in history.
As soon as it began to unfold, China, on January 23, took the unprecedented step of putting a quarantine on the city of Wuhan 11 million people. They closed stores canceled plane flights and trains and brought oil demand to a near standstill. But that was just the beginning. Soon China expanded the order to the entire province of Hubei, effectively parking nearly 56 million people. This came on the important Lunar Day holiday for China. The Chinese authorities saw a drop of almost 30 percent in travel from the year before. In an attempt to slow the spread of the virus, they decided to extend the Lunar Day holiday to February 2. In China, factories are still closed and will remain closed. Hundreds of flights out of Wuhan and the surrounding 16 cities in Hubei Province.
This week the WHO declared the outbreak a "public health emergency of international concern" and another bold step unfolded Thursday when the U.S. State Department issued a "Do Not Travel to China" advisory.
Initially, global oil demand destruction was estimated to be around 200,000 barrels a day. Yet now as the virus fears spread its probably more than twice that amount. Due to canceled flights in China and across the globe, we are probably going to see 300,000 barrels a day of lost jet fuel demand alone.
On Friday, American Airlines and Delta issued additional flight reductions to the region.
Because of that, it looks like OPEC along with Russia, is in talks to add another 500,000 barrels of production cuts to offset the demand loss but if the virus fears continue to slow global economic growth, it might not be enough.
On top of that, we have had a warm winter around the globe. That caused a significant drop in diesel and jet fuel demand and pushed prices to a one-month net decline not seen since November 2018. Gas prices are also seeing substantial reductions having its most extensive one month net and percentage drop since August 2019.
It also did not help to see that China’s manufacturing sector was struggling before the reports of the outbreak happened. China’s Purchasing Managers’ Index (PMI) fell to 50.0 in January from 50.2 in December, China’s National Bureau of Statistics (NBS) said on Friday. The reading was in line with analysts’ forecasts and hit the neutral 50-point mark that separates growth from contraction on a monthly.
Yet what could also hurt demand is fear. Fear that the virus could spread. It is now being reported that the coronavirus has spread from China to around 20 countries, killing more than 200 people. If people start to fear the virus and stay home, it could have a more significant impact on the economy.
Already we are hearing that Chinatown in Chicago is seeing a drop in restaurant business. So if fear overtakes reality, we could see oil back in the forty dollar handles. On the flip side, any world of a vaccine or a cure could quickly change the mood and will head back into the ’60s as the market will expect pent up demand.
More than likely based on past events at some point this will be a significant buying opportunity.