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In just little over two months' time, a SARS-like novel
coronavirus (COVID-19) that was first reported from Wuhan, the
capital city of Hubei Province, has quickly escalated into what is
described by many as an unprecedented outbreak, infecting 24,377
people in China and spreading to over 24 countries worldwide by the
time of this writing on 5 February 2020. The Chinese government has
raised the emergency response to the highest level since the second
half of January in a race to fight and contain the virus. The
government issued a strict travel ban to and from Wuhan on the eve
of Chinese New Year to limit further spread of the virus outside of
the epicenter, and has ordered businesses in 23 provinces to remain
shut at least until 10 February to minimize risks of human-to-human
transmission. People have been advised to stay at home and cancel
all unnecessary travel and gatherings in spite of Chinese New Year
traditions, while all airlines and rail service providers have been
requested to provide passengers full ticket refunds free of
charge.
Figure 1: Suspected and confirmed cases of 2019-nCoV in
China
The outbreak has sent rippling shockwaves through the entire
spectrum of China's economy, starting from transportation,
manufacturing, and construction, all the way down to tourism,
retail, and other commercial services, with the oil market among
the most acutely affected. Stringent government controls and
people's heightened awareness have virtually dried up the country's
mobility of people and goods to a slim share of their respective
normal levels, with passenger turnover during the Chinese New Year
holiday by air, by train, and by road dropping drastically year on
year by 51.7%, 68.7%, and 65.1%, respectively.
The outbreak comes as a significant blow to refineries that were
well stocked in anticipation of the supposed Chinese New Year
demand spike, catching them completely off guard with the resulting
soaring product inventory, deeply depressed margins, and gloomy
demand prospects. Though it is hard to tell how the virus outbreak
will evolve at this point of time, our base-case scenario assumes
the resulting market disturbance will reach its peak in February
before tapering out in March and beyond as strong government
measures and extensive medical care wins over the raging virus.
In view of the weak fuel demand, logistics restrictions, and
reduced worker availability, Sinopec and PetroChina plan to cut
refinery runs by 2.5 million metric tons (MMt) and 1.2 MMt,
respectively, from their original February targets, equivalent to a
reduction of 630,000 b/d and 300,000 b/d, respectively. Refineries
in Hubei and surrounding provinces will effect the steepest
throughput cut of 20%, whereas refineries in other less-affected
regions will trim their throughput by roughly 10% depending on each
refinery's unique circumstances. Independent refineries, a group of
swing producers to begin with, are geared for even deeper cuts of
more than 3.2 MMt, or 800,000 b/d, from pre-outbreak levels with
many already operating at the lowest possible rates.
This means the virus outbreak will knock out at least 1.7 MMb/d
of refinery runs in February from an otherwise projected growth of
760,000 b/d, resulting in the sharpest single-month decline of 1
MMb/d in history. However, even a production cut of such massive
scale will not be enough to save refineries from another month of
strong inventory build, as traffic bans and subdued downstream
demand keep these barrels from going anywhere besides into refinery
storage. Refineries will likely need to extend their production cut
throughout March in order to work off the excessive product
inventory, but the magnitude of the reduction will likely come down
to 500,000-600,000 b/d on a yearly basis if demand recovers
following the resumption of business activities and easing of
government restrictions. Refinery runs are expected to flip back to
positive growth in April before further normalizing to original
growth assumptions in May and beyond. However, even if the market
disturbances prove to be as short-lived as expected, it will
nonetheless reduce China's crude demand by as much as 250,000 b/d
on an annualized basis, dragging runs growth down to half of what
would be expected if the outbreak had not happened.
We estimate that China will need to slash its crude imports by
as much as 900,000 b/d on average over the course of the next four
months in order to bring the country's crude supply and demand back
to balance, an annual reduction of 300,000 b/d from our previous
projection. This will exacerbate the already sizeable supply
surplus of over 700,000 b/d expected in 2020 globally, indicating
the need for extended, and possibly larger, production cuts from
the Vienna Alliance. Oil prices will be fundamentally pressured in
first and second quarter 2020 across all key benchmarks, but the
Brent-Dubai spread is likely to narrow should the Vienna Alliance
agree on more aggressive production cut targets.
Figure 2: China crude imports
China's crude imports will not register a material decline in
February as most cargoes arriving were purchased before the
escalation of the 2019-nCoV outbreak, but we expect that companies
who have the flexibility will start to resell some of their booked
March cargoes to ease storage buildup and port congestion. Trading
houses that serve the Shandong independent segment will prioritize
the resale of long-haul barrels, such as Brazilian Lula, Congolese
Djeno, and the North Sea Johan Sverdrup barrels, whereas
state-owned refineries located in and close to Hubei Province may
also opt to redirect excess West African barrels that make up as
much as 40% of their typical crude slate Reflective of
independents' drastically lower crude demand, the premiums of
Shandong delivered ex-ship cargoes against Brent futures of all
actively traded grades have plunged by more than 50% from their
respective pre-outbreak levels by the time of this writing.
Sinopec's trading arm, Unipec, has also reportedly suspended March
loadings of West African crudes and is looking to re-sell several
previously booked cargoes through spot market. Middle Eastern term
supplies, on the other hand, will see a direct reduction in Chinese
liftings for March deliveries and beyond, as a large share of these
term barrels are governed by destination clauses and not suited for
resale purposes.
Xiaonan Feng is a research analyst and a member of Oil
Markets, Midstream, Downstream and Chemicals (OMDC) team at IHS
Markit.
