(Bloomberg Opinion) -- The coronavirus outbreak is already threatening oil markets. The fear of lower demand — from a disease-stricken China and eventually globally as the economic impact widens — has destabilized prices, sending crude to its lowest levels in more than a year. For major oil-producing countries, the declines, coming at a time of curtailed output, threaten economic shocks that if long-lasting could lead to the kind of political and regional instability that was avoided during the last steep drop.
China is the largest oil importer in the world by far, and its biggest suppliers are Saudi Arabia and Russia. In December, China’s General Administration of Customs reported oil imports of nearly 11 million barrels per day. With the virus still yet to be contained, people with inside knowledge of the Chinese energy industry estimate that oil demand in the country has dropped by about 3 million barrels a day, or 20% of total consumption.
We don’t yet know what toll the virus will take on global oil demand, especially if an economic slowdown spreads beyond China; estimates from BP (LON:BP) Plc and OPEC put potential losses in the 200,000 to 600,000 barrel-per-day range. As containment efforts fall short and quarantine measures become more severe and widespread, markets need to consider that the worst-case scenario might be more realistic than previously assessed, and be mindful of the possible reverberations.
A catastrophic situation for the oil industry might see prices dropping into the $30-to-$35 per-barrel range for Brent, and lasting for several months. This situation presents a particular problem and threat for oil producers that would be significantly more severe than they faced when Brent prices last dipped into the low $40s and mid-$30s in 2015 and 2016. Then, the price of oil fell because producers were pumping as much oil as they could. But if prices were to fall that much now due to the coronavirus outbreak, it would happen at a time when most producers have tempered their output.
OPEC and its partners in OPEC+ are limiting production, and even considering further cuts to combat the demand destruction. So, in the feared coronavirus scenario, producers such as Saudi Arabia, Russia and the United Arab Emirates would face low prices in conjunction with lower production. This would severely curtail their revenue. If, for example, Saudi Arabia exports 6.85 million barrels per day (which it did in January 2020, according to data from TankerTankers.com) and the price of Brent dropped $20 per barrel without any increase in production, its state-owned oil company Aramco (SE:2222) would lose $137 dollars per day in export revenue – or almost $4.2 billion per month.
Should this low-demand/low-production scenario come to pass, countries such as Saudi Arabia, Russia, the United Arab Emirates and others would face direct hits to their coffers. Their deficits would rise; the services provided by their governments to satisfy the populations might be reduced; and their economies would suffer. If the situation lasted long enough, economic instability could have political consequences.
The U.S., currently the world’s largest oil producer, wouldn’t be immune; producers there would face harsh business consequences but for different reasons. Unlike OPEC+ countries, U.S. oil firms, particularly shale firms, are producing at record rates. However, most companies producing in the shale-oil patch have higher break-even points than big oil producers elsewhere. If prices drop significantly and don’t recover quickly, the U.S. could see another oil bust, resulting in bankruptcies and layoffs. And while coronavirus might bring lower gasoline prices for American consumers, it is equally likely to strike the U.S. economy in one of its most successful sectors.
The worst-case scenario may well be avoided and certainly that’s to be hoped for, in the name of world health and economic stability; but with the crisis still raging and so many unknowns, it’s prudent to consider all possibilities.