Coronavirus fallout drives chaotic week in energy markets
While the world is grappling with the spread of the coronavirus, markets are seeing extreme volatility as governments around the world enact measures to try and manage the crisis.
Stock Markets Fall, Energy Markets Feel Impact
Since reaching a record high on February 19, the S&P 500 had dropped nearly 27% at close of trading on March 12, due to the decrease in economic activity and reductions in the global growth forecast. The impact on the global economy is cascading down to energy markets, where both spot and futures pricing have slid after current demand and near-term future demand projections have been slashed.
Prices are moving erratically with near daily shifts in market fundamentals coupled with ever-changing predictions and perceptions.
Potential for an Oil Price War
Amongst energy commodities, oil is experiencing the greatest shake up. In an initial response to the decreases in global demand, specifically in China, the spot price of West Texas Intermediate (WTI) fell over 10% by the end of February 2020 from December 2019 average of $59/BBl.
To counteract the impacts of the decline in demand, the Organization of Petroleum Exporting Countries (OPEC) announced an intention to scale back production. However after failing to reach a production curtailment agreement with Russia, a Saudi Arabia-led OPEC pledged the opposite: to flood the market with discounted oil. Threat of an oil price war in an already oversupplied market sent prompt prices at NYMEX – Cushing, OK crashing to $31.13/BBl at the closing bell on March 9, the lowest close since February 2016.
Natural Gas Prices Drop
Like oil, natural gas prices have waned, with the forward 12-month rolling strip at NYMEX Henry Hub reaching its lowest point ever, closing February 28 at $2.0504/MMBtu. Since natural gas as a commodity is not nearly as global as oil, it can be somewhat insulated from global shocks.
This time, though, gas was not impervious, as February Henry Hub daily spot prices also set a new record, averaging below $2/MMBtu for just the second time in the past 20 years, below the previous bottom (set in 2016), by nearly 9%.
The LNG Outlook for Consumers
Although the low-priced environment may be a temporary boon to consumers, any extended reduction to demand may alter the supply landscape and have a lasting effect on supply-demand fundamentals.
US natural gas prices had already been trending down throughout 2019, as mild winter weather and record production levels continued to drive conditions of oversupply. The low prices have placed severe pressure on producers, but many have been awaiting the completion of several natural gas and liquefaction terminals to enable greater export of natural gas abroad, where supply is not keeping up with demand and prices are higher.
The virus has been a major blow to LNG exports to China, which has been a quickly growing market for American producers. In June 2019, for instance, the EIA released a report projecting the US to be the global leader in LNG exports by 2024, with China and India set to be the primary off-takers of the additional supply (Chinese demand for LNG doubled between 2016 and 2018). But short-term LNG demand in China was reduced significantly and several planned shipments have been cancelled.
In the near-term, stranded LNG continues to put downward pressure on domestic gas markets, but may also make prospects of new LNG export projects bleak, until global demand and prices rebound.
Will OPEC Reach an Agreement?
Despite OPEC’s pronouncements, there is still a possibility that production cut agreements could be made. Regardless, American drillers of crude oil are expected to start to decrease rig count and attempt to weather the low prices.
Independent producers without the coffers to withstand the sudden drop in profitability may not be so lucky. Although inventories are currently building amid the recent demand slump, when demand returns there may be a lag in supply and subsequently increased volatility in pricing.
What, If Anything, Can Market History Tell Us?
The severe drops in financial markets are drawing parallels to 2008 and stoking fears of an extended recession. However, it is important to note that the dynamics for energy commodities are markedly different today than they were in the late 2000s.
Prior to the COVID-19 outbreak, prices were significantly lower than they were in 2008 before the financial crisis. For comparison, at the beginning of 2008, prompt oil was trading near $100/Bbl, while natural gas was consistently north of $7/MMBtu. Since 2008, shale production of oil and natural gas has grown the supply of both substantially, and in December 2019, natural gas prompt prices were trading around $2.15/MMBtu. Even if the virus continues its spread, it is unclear how much further prices can go downward.
In the interim, markets are likely to continue to experience jolts as large corporations and governments make sweeping decisions on not only how to best contain the virus but also limit its fallout. In only the past week, the S&P 500 at one point rose over 4% day-over-day on the promise of a US economic stimulus, only to relinquish its gains the following day on the announcement of enhanced travel restrictions. Although the situation continues to evolve daily and there are many unknowns, one thing is certain: commodity prices haven’t been this low in a long, long time.