Transportation fuel market prices experienced massive decreases on Monday in the face of an oil price war and ongoing demand concerns centered on the coronavirus (COVID-19) outbreak. Last week’s meeting between OPEC and its allies (OPEC+) was expected to conclude with a renewed strategy to balance the oil market and stabilize prices amid COVID-19’s international expansion but instead ended with a lack of Russian agreement. This move hastily motivated Saudi Arabia to declare a price war, verbally end the OPEC+ alliance, and increase production.
The abrupt departure of Saudi Arabia, Russia, and other producers from a policy of restraining supply to support prices fundamentally changes market economics.
The threat of additional supply entering the market comes as COVID-19’s impact on the world economy has led to softer crude oil demand and, as a result, downward price behavior. Reports of the global oil supply-demand gap widening caused Brent crude oil prices to fall over 20 percent to around $35 per barrel as of the early afternoon on March 9. The diesel market responded similarly, falling about $0.20 per gallon in the same period. Pending any drastic changes before market close, today’s turbulence will send tomorrow’s national wholesale diesel price to levels last seen in August 2016 between $1.90-1.95 per gallon.
The Coronavirus Demand Shock
COVID-19’s accelerated spread across major economies throughout Asia, Europe, and the Americas stoked demand fears and triggered another wave of considerable downward price pressure in recent weeks. Non-China COVID-19 cases now account for over 25 percent of the world’s total, raising speculation that oil and refined product demand will wane further as global travel bans and border closings drag down economic activity in numerous G20 economies. The virus has single-handedly washed out the vast majority of the market’s upside price risk and makes a rebound even more dependent on containment timelines and supply-side market developments.
The lingering threat of COVID-19 caused the International Energy Agency to cut its 2020 oil demand forecast by 1.1 million barrels per day in its most recent report, with expectations for year-over-year demand to decline for the first time since 2009. Most of this dip in oil demand is expected in the first and second quarters with a rebound thought to emerge in the second half of this year. This remains heavily dependent on the COVID-19’s lifespan and whether alternative actions are taken to bring supply and demand into balance.
The OPEC+ meeting’s collapse and Saudi Arabia and Russia’s newfound desire to increase production amid a price war, however, cover up perhaps the one thing that could have stabilized the energy market in the near term.
The group is expected to abandon its existing production cuts of up to 2.1 million barrels per day on April 1, signaling the market will be flooded with oil in the months ahead. This increase in production, paired with weaker demand projections from the IEA, creates a significant market surplus between 2 and 3.5 million barrels per day for the next few quarters. This is highlighted in the chart above.
The OPEC+ Supply Shock
OPEC+ leaders decided deepening cuts another 1.5 million barrels per day through the end of 2020 would have narrowed the newfound supply-demand gap stemming from COVID-19 and injected some upside back into oil prices. However, the meeting thought to require participants to lower production and mitigate softer demand from COVID-19 ended in disarray due to Russia’s unwillingness to cut production further. OPEC would have been responsible for 1.0 million barrels of daily cuts, while its allies—led by Russia—would have taken on another 0.5 million.
Saudi Arabia determined the existing cuts of up to 2.1 million barrels per day across 20 participants would end on April 1. This decision was made knowing its market share would be put further at risk following Russia’s departure from the agreement. Instead of deepening production cuts through 2020 altogether, Saudi Arabia expressed the existing cuts of up to 2.1 million barrels per day across 20 participants would end on April 1. This will allow the OPEC+ nations to produce quota-free from that point onward, creating an element of supply uncertainty to go along with the unknown demand timeline associated with COVID-19.
The beginning of this oil price war between Saudi Arabia and Russia leaves the market faced with prices incapable of supporting many oil-dependent economies of the Middle East. Additionally, it may force major non-OPEC+ members, like the United States, to reduce their own output to keep prices at an economically viable level for producers. This could naturally cause the U.S. to cede some of its oil market share as it appears the “produce as much as you want” mentality that certain countries are likely to attain will not subside overnight.
The next OPEC meeting is scheduled for early June and it remains unknown if the group will re-introduce a strategy aimed at market balance, or if they will continue to produce without constraint. The future of the OPEC+ relationship also remains uncertain. For now, the global oil market will act independently from cartel-imposed guidelines.
Impact of COVID-19 and OPEC+ News on U.S. and Canadian Fuel Markets
COVID’s persistent price influence has had a profound effect on the U.S. and Canadian wholesale diesel market.
Since January 1, national average wholesale diesel prices in the U.S. and Canada have fallen over 50 cents per gallon and closely mirrored oil market price moves. Recent OPEC+ news will likely continue this trend and keep diesel prices in both countries near multi-year lows.
Impact of COVID-19 and OPEC+ News on Maritime Fuel Markets
The OPEC+ decision to relax its crude oil supply quota helped the new, 0.5 percent sulfur very-low-sulfur fuel oil (VLSFO 0.5%S) continue its downward price progression.
The large premiums for low-sulfur fuel through the December to January fuel market help to explain why VLSFO and low-sulfur marine gas oil (LSMGO 0.1%S) prices have fallen at a quicker pace than Brent crude. Meanwhile, high-sulfur fuel oil (IFO 380 3.5%S) has seen less downward price movement because it had already been heavily discounted as its demand evaporated through the IMO 2020 transition.
Impact of COVID-19 and OPEC+ News on Mexico Fuel Market
Diesel prices in Mexico have also shown a profound connection to the coronavirus’s oil price impact and will be subject to price implications of the OPEC+ news soon.
National average retail less VAT diesel prices have fallen over 2 percent since January 1 and have retained their connection to the broader energy market. Mexico’s adjustable excise tax allows the government to smooth price volatility, but the market’s recent downward slide forced the government to maximize this tax, making it unable to absorb any additional downward price behavior.
Impact of COVID-19 and OPEC+ News on European Fuel Market
European fuel prices have shown a noticeable downward shift in recent weeks after relative price stability through the first few weeks of COVID-19’s relevance.
Retail less VAT diesel prices dipped over 8 percent from January 1 to early March, with a downward trend likely going forward based on COVID-19 developments and an imbalanced oil market.
Fuel Market Impact Moving Forward
We believe the combination of COVID-19’s ongoing international expansion, the removal of OPEC+ production constraints, and an alleged oil price war in the fight for market share will lead to sustained lower prices in the months ahead. The exact longevity of this bearish course is dependent on COVID-19 containment timelines, improvements on the economic demand front, and developments on the supply side.
The Breakthrough Applied Knowledge Team will offer more insight in the weeks ahead as we continue to analyze how COVID-19 and the OPEC+ announcement impact fuel market fundamentals.