Why This Year’s Oil Outlook Changed So Quickly

It was barely a month ago that I made the prediction “For the first time since 2014, the closing price of WTI will not drop below $50/bbl.”

At the time that was a reasonable prediction. Oil prices were trading at nearly $60/bbl, and OPEC was cutting production to offset the ongoing surge of U.S. crude oil production. Further, I believe that the near term threat on crude oil demand from electric vehicles is grossly overestimated.

Up to this point, the notion that oil demand is under siege has been an incorrect perception. Oil demand has been increasing by more than a million barrels per day, year after year, for the past 10 years. Further, that demand growth isn’t noticeably slowing down. The biggest problem with the oil markets has simply been that shale oil growth in the U.S. has outpaced demand growth, putting downward pressure on oil prices.

This confluence of trends promoted me to project a healthy year for the broader energy sector. What a difference an epidemic makes.

How Quickly Things Changed

But shortly after I made the prediction, news starting coming out of China that people were dying from a new virus strain. Since then, that news has just gotten worse and worse. So far over 70,000 people have been diagnosed with Covid-19, a new strain of coronavirus. The death toll is now approaching 1,800, nearly all in China.

Beyond the obvious concern of a potential deadly pandemic sweeping the globe, this outbreak presents an immediate change in the outlook for oil. Why? Because China is the world’s largest consumer of oil.

To contain the virus, Beijing is taking aggressive measures that are hurting the Chinese economy. (At least one economist is warning that the virus will paralyze China). As the world’s largest oil consumer, a slowdown in China’s economy suddenly has a real potential of causing global oil demand to fall for the first time in a decade. Citigroup (NYSE: C) analysts have suggested that the virus could reduce oil demand by 1 million barrels a day (BPD), but this is still clearly a developing situation.

OPEC’s Hands Are Tied

OPEC must now contend with U.S. shale oil growth and a negative short-term impact on demand. That has the oil markets and the broader energy sector plummeting. Oil prices have shed nearly 20% in four weeks, but it’s hard to say where the bottom may be with the outbreak still growing.

OPEC tried to get ahead of this situation. Although the cartel and its partners announced production cuts in December, that was before it was apparent that this would be a potentially serious outbreak. OPEC convened an emergency meeting with Russia in the hopes of announcing additional production cuts of 600,000 BPD. This time, Russia refused. The country needs the revenues.


Meanwhile, oil prices could fall further, if the outbreak continues to grow. At present, that looks likely. How far prices fall at this point will be a function of the spread of the virus and OPEC and Russia’s eventual response (or lack thereof). The oil cartel isn’t expected to take up the issue again until a meeting in March.

Be Careful Out There

How should you play this as an investor? Very cautiously. This is a black swan event. Former Wall Street trader Nassim Nicholas Taleb coined that phrase to describe rare, outlier events that can’t be predicted beforehand, but which have potentially huge consequences.

There is precedence for a real economic impact from these sorts of outbreaks. Oil prices fell nearly 20% during the 2002-2003 SARS outbreak, albeit the impact was relatively short-lived because the outbreak was brought under control.

But the thing to remember about black swans is that by their very nature, you never know when they will pop up, or how much damage they may ultimately cause.

Meanwhile, my January prediction on oil prices fell in record time. Four weeks after I made the prediction the closing price of West Texas Intermediate (WTI) had fallen 20% to close at $49.59/bbl.

This one seems far from over though. Stay tuned.

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