March 23, 2020 [CSIS] – The coronavirus, also known as COVID-19, is not only a global public health emergency but also a source of significant regional and increasingly global economic disruption.
This impacts the energy and climate world in many ways. The economic downturn puts pressure on global oil prices leading the Organization of Petroleum Exporting Countries (OPEC) to consider further cuts to production. It hurts demand for natural gas during a time of extremely low prices. It changes the economic, energy, and climate policymaking environment in China, one of the most consequential energy consumers and sources of greenhouse gas emissions.
And it has temporarily disrupted supply chains throughout the energy industry, including renewable energy, at a time when supply chain connections with China were being reevaluated due to ongoing tariff and trade disputes. How consequential or transformative any of these changes are for the energy sector or for climate efforts will depend upon the ultimate trajectory of the virus outbreak itself.
Senior Vice President and Trustee Fellow, Energy Security and Climate Change Program
As OPEC convenes this week, member states will almost certainly attempt to retake control of the market. But in the face of unknowable uncertainties, they are equally likely to come up short no matter how ambitious an effort is forthcoming.
In the past few weeks as the coronavirus has spread beyond China to greater Southeast Asia, parts of the Middle East, Africa, Europe, Latin America, and more recently to the United States, commodity prices have been in freefall.
As a consequence of reduced air travel, lower economic activity, and refinery shutdowns, crude oil demand is projected to be less than one-half the rate of previous forecasts, necessitating action to curb additional output. The OPEC ministerial meeting on March 4 produced a recommendation calling for an additional 1.5 million barrel per day (b/d) cut for the OPEC-plus Alliance through June 30 and continuation of the current (previously agreed upon) cuts through the end of the year.
If approved by the Alliance, the additional cut would be split between OPEC members (at 1 million b/d) and the non-OPEC alliance countries (500,000 b/d), particularly Russia. Russia will likely find the larger suggested cut distasteful but are nonetheless expected to join the collective action even if their “contribution” is likely to be modest and slow to materialize. In the interests of preserving the OPEC Alliance pact, the Saudis are likely to assume a large portion of the reduction obligation even as they seek recognition for their previous overcompliance volumes.
All that said, the combination of the uncertainty surrounding the duration and extent of demand destruction, coupled with still growing supply and rising inventory levels, will conspire to delay meaningful price improvement even after economies begin to recover.
Senior Associate (Non-resident), Energy Security and Climate Change Program
The emergence of COVID-19 as a serious threat to oil demand is well known. Extensive quarantine measures have had a significant impact on Chinese demand for transport fuels while also threatening overall economic growth. The spread of the virus to other countries, as well as fear of further spread, has had an impact on international transport demand and economic growth in Asia and now increasingly other regions. Finally, interruptions to the global manufacturing supply chain are impacting industrial fuels such as naphtha and diesel.
Prior to 2020, most projections had global oil demand in 2020 growing by about 1.2 million b/d, with China accounting for almost 450,000 b/d of that growth. China’s oil demand is now likely to be flat in 2020 with gasoline, diesel, jet fuel, and bunkers contracting and naphtha and liquified petroleum gas slowing. With lower growth in other Asian countries and elsewhere, global oil demand is now projected to grow by between 400,000 and 500,000 b/d. Even as transport fuel demand contracts, continued moderate growth in ethane and liquified petroleum gas demand will keep total global oil demand from contracting. Many forecasts are more pessimistic, suggesting flat demand or a contraction for the year.
Global forecasts for oil demand are getting gloomier and gloomier on the back of the assumption (perhaps true) that the virus will continue to spread in much more serious ways throughout the world. One can imagine a more positive scenario, though, where medical researchers all over the world succeed in containing this virus by developing methods to test for the virus and provide medical support for infected individuals.
Countries with modern, transparent health care are taking steps that should lessen the impact of the virus as it spreads. Moreover, the public in most countries is now far more knowledgeable about the virus and prevention than the residents of Wuhan, who were taken entirely by surprise.
Given this outlook, we could be facing a demand profile that looks a bit like a hybrid of the SARS experience of 2003 and the financial crisis of 2008. SARS hit demand hard in the second quarter of 2003, but as the spread of the virus was brought under control, demand bounced back with a vengeance. As soon as COVID-19’s spread is brought under control in the new countries where it is breaking out, pent up demand should bounce back later this year.
That is the most important factor in a scenario where global oil demand does not contract this year. But if COVID-19 is more of a structural economic blow given its impact on the supply chain, international travel, and Chinese growth, then one begins to think of 2008—when oil demand did not recover until the next year. It is likely that COVID-19 will end up somewhere in between the two.
Senior Associate (Non-resident), Energy Security and Climate Change Program
The financial markets have gone through a very aggressive revaluation process in light of the coronavirus outbreak. All financial assets have been impacted. China is the largest crude oil importer and Asia-Pacific the demand driver for petroleum products, materially affecting energy prices. Futures markets tend to overextend price movements when volatility increases.
Futures markets can delink from physical markets in these conditions as noncommercial participants react to real time events. We have witnessed a fair amount of this over the last couple of years. Global markets react almost instantly to headline news in the fast pace of information today, while the longer-term implications will be difficult to discern for some time to come.
The current price structure where prompt barrels are a discount to forward barrels encourages storage plays as these barrels become cost free to store. The open questions are how much goes into storage, and how long does the build last before a balanced supply demand structure presents itself. This also suggests some further reduction of supply by OPEC+. There are various levels of uncertainty regarding depth and width of the global economic impact we are experiencing. This should manifest itself in continued high price volatility.
Supply discipline is hard to maintain in this environment. The level of stock build and duration will set the underlying fundamentals of price.
Senior Fellow, Energy Security and Climate Change Program
The COVID-19 outbreak is kneecapping demand in a gas market that was already both weak and overly reliant on China. Prices have dropped sharply. Henry Hub in the United States has fallen by 22 percent so far in 2020 (to February 28); the Title Transfer Facility in the Netherlands by 26 percent; and the Japan Korea Marker, the main benchmark for spot liquefied natural gas (LNG) in Asia, by 44 percent. In Europe, gas storage facilities are over 60 percent full, far above what is normal in the end of February (around 40 percent). In the United States, gas in storage is slated to reach a record level in 2020.
The drop in prices is producing some obvious results. Buyers are looking to defer or even cancel deliveries of contracted gas. They are exploring options to renegotiate contracts that force them to pay far higher prices for LNG. They are trying to boost their purchases to benefit from cheap gas. But the outbreak might trigger a prolonged contraction that the industry is unprepared for.
Producers might curtail production due to lackluster demand. Newly completed projects might be unable to repay debt. Governments may favor coal to help their economies rebound. Oil-indexed pricing, which keeps prices artificially high in Asia, will come under great strain. This might be a fatal blow to that pricing model.
In other words, the COVID-19 outbreak will deepen and prolong a period of low prices that was coming anyway. There will be enormous pain, at least if the economic downturn is as severe as it now looks. But gas might also finally rid itself of oil-indexed pricing, offering a product that is more competitive and hence better able to find its spot in the energy transition. That would be the one silver lining to emerge from an otherwise very difficult moment.
Research Associate, Energy Security and Climate Change Program
The coronavirus is increasingly expected to hurt the global growth of zero-carbon energy this year—but by how much remains to be seen. Many of the world’s largest solar, battery, and wind manufacturers produce in China. The Chinese government has restricted domestic travel and briefly halted all manufacturing in eight provinces, including those that major clean energy manufacturers call home.
Analysis firm BloombergNEF has lowered their forecast for Chinese battery production by 10 percent this year and expects the country could see some small dips in solar and wind installations in the domestic market (but they caution this could change if the country is able to ramp production back up quickly enough). Fortunately, production began ramping back up toward the end of February, but it will take a while for them to reach full capacity again.
This does not solve the problem for installations or even manufacturing outside China, however. China’s aggressive response to the outbreak hindered the movement of Chinese workers, and shipments of parts to other countries are delayed. (Wind turbine parts being an exception as their exports have not been restricted.) The slowdown in exports is already delaying projects in other parts of the world, and further delays could start driving up costs in the short term. Unless other countries can develop new supply chains, project developers have to hope that Chinese manufacturers will be able to recover quickly and avoid further production slowdowns.
Will developers look to diversify their supply chains away from China as a result of the coronavirus? Seeing as how the work stoppages in China lasted less than a month and direct impacts appear to be muted (even though the ripple effects will continue for some time), it seems likely that this will be a relatively short-term disruption rather than a long-term shift to supply chains.
Senior Associate (non-resident), Energy Security and Climate Change Program
Last week, the IMF said that the outbreak would likely lower China’s economic growth this year to 5.6 percent, 0.4 percentage points below its earlier estimate in January. China was already on track to meet its emissions targets for 2020, so this additional reduction in emissions would enable China to exceed its carbon emissions targets. However, sluggish growth at the end of 2019 had already started conversations in Beijing about stimulating economic activity by lowering environmental taxes and delaying the implementation of any substantive climate policies. The coronavirus outbreak puts those fears on steroids.
The longer the shutdowns continue, the more drawn out any recovery becomes as the impact on incomes and employment compound. Many economists are predicting a first quarter contraction and potentially challenges in the second quarter. As a result, the Chinese government is eager to get workers back on the job and has been pushing firms back to work. But caution remains high. While Anheuser-Busch has reopened half its Chinese breweries, and the movie theaters have reopened, moviegoers better go alone as theaters are only selling non-adjacent tickets in alternating rows. Confidence simply isn’t there yet.
To regain lost economic ground and provide essential financial stability, Beijing will likely move heaven and earth to reach its growth targets for the year. A rebound in the 9-15 percent range for quarters 3 and 4 will be necessary to reach the 6 percent target. While possible—refilling orders and inventories could bring a massive surge of activity—that assumes global demand is not faltering as the rest of the world confronts COVID-19.
Regardless of whether these targets are met, environmental concerns are likely to be lost in the wind for the near future. Surging economic activity will bring back high pollution levels and greenhouse gas emissions. And, while air pollution is bound to get Beijing’s attention again, climate advocates are likely to feel like they are sitting alone in a Chinese movie theatre.
Associate Fellow, Energy Security and Climate Change Program
The economic fallout of the coronavirus has seen a dramatic fall in carbon dioxide emissions in China, the world’s largest contributor to climate change. CO2 emissions are about 25 percent lower than they otherwise would have been, due largely to a fall in the industrial activity that is at the heart of China’s emissions and pollution problem. Over just a three-week span, the emissions avoided due to this tragedy are the equivalent of almost one-half the annual emissions of Australia.
This is no cause for celebration, however. Not only has the virus killed nearly 3,000 people across China (as of March 5), but emissions and air pollution will likely return to normal once the panic has passed. Chinese growth depends disproportionately on high levels of investment in heavy-industry sectors, such as steel and cement production, which require large amounts of energy. Most of this still comes from coal through both direct and electricity consumption.
While there has been some progress in shifting its economy away from investment-led growth to a more consumption-oriented economy, this “rebalancing” has become a lower priority as Xi Jinping has consolidated power in the last few years. Chinese authorities are unlikely to rewrite the economic playbook and will likely turn the tap on investment back on as they attempt to recover lost economic ground as a result of this crisis.
There is the chance that authorities choose to use the cover of a pandemic to trim the fat in inefficient (and carbon-intensive) industries. Furthermore, they could respond to mounting political pressure through measures that boost household income and accelerate this “rebalancing.” However, most signs point to another stimulus package through the traditional tools of public infrastructure spending and real estate development.
Climate change is a complex enough crisis without adding a pandemic to the mix. The coronavirus is unlikely to change China’s carbon-intensive growth model, no matter its short-term impact. We would do well to instead wish China the speediest of recoveries.
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