For a generation of oil traders, so-called geopolitical shocks once meant conflicts and social ruptures that threatened supplies in the Middle East, and which almost invariably sent prices spiralling higher.
But at the start of 2020, a new reality has become cemented in even the most battle-hardened minds: this will be the decade when demand shocks become a bigger risk than sporadic threats to supplies.
From the long-term threat of “peak oil” demand to short-term hits to consumption, the oil market is now well enough supplied that fears of outages are being subsumed by worries over the world’s thirst for crude.
An obvious illustration is oil’s reaction to the coronavirus outbreak in China. Prices have dropped more than 15 per cent from their early January peak to below $60 a barrel, as restrictions on transport — a direct blow to oil demand — and fears over the wider economic fallout have sent traders running for cover.
The move comes despite a loss of supplies from Libya, where outages caused by the 2011 revolution helped propel crude above $120 a barrel. Now, output is almost completely shut off by an export blockade by forces challenging the UN-backed government in Tripoli.
A few diehard oil bulls have pointed out that the loss of more than 1m barrels a day from the North African country, equivalent to more than 1 per cent of global supply, exceeds even the most bearish projections for the coronavirus’s impact on demand.
But the price reaction is telling. Traders have little doubt about the market’s ability to cover short-term supply shortfalls, be it from US shale production or Opec spare capacity. Even so, they have largely ignored Libya and zeroed in on the impact of the coronavirus instead. Brent, the international oil benchmark, has lost more than any other asset class since the scale of the health crisis started to emerge.
It is little surprise then that Opec has gone back to its well-worn playbook, starting to talk up the possibility of making deeper cuts to production to prop up the market. This has become commonplace since 2016 when the group first combined with Russia to try to boost prices. But talk of cuts is telling nevertheless when some of Opec’s own members such as Venezuela and Iran — in addition to Libya — have reduced production because of conflict and sanctions.
That represents an acknowledgement from the cartel that demand shocks, rather than supply shocks, now set the pace in the market.
Opec members may still try to argue that fears over long-term demand are overstated and that demand will stay solid as long as emerging economies are industrialising. But look at what they do, rather than what they say. The strongest members such as Saudi Arabia are doing everything they can to diversify their economies away from their near-total reliance on oil.
The political backlash against fossil fuels has intensified in the past year and shows little sign of fading. International oil companies are under growing pressure from investors to find less damaging ways of fuelling the planet, while efforts to curb consumption are likely to eventually spread from Europe to the largest emerging economies. The long-term outlook for demand growth looks shaky, at best.
There are still vulnerabilities in the oil market. Supply risks are not insignificant. The drone and missiles attack on Saudi Arabia’s oil installations last September could have had a much more dramatic impact if the kingdom had not been able to restore exports so quickly. A direct military confrontation between Iran and the US would still have the power to unnerve the market and boost prices, at least temporarily.
But traders are not as on edge as they once were. Crude prices were relatively steady near $60 a barrel for much of last year, even as tensions rose in the Middle East. Price rallies much above that level look increasingly difficult to sustain.
Traders are acting accordingly, responding more to threats to demand such as the coronavirus — even if its full impact remains, at best, an educated guess. Analysts are estimating that demand could fall anywhere from 150,000 b/d to 600,000 b/d, but there are still fears the effects could be worse if the virus starts to really weigh on the global economy.
Looming over the market now are memories of the last quarter of 2018, when signs of an economic slowdown led to a sell-off across equities and commodities that dragged crude below $50 a barrel, in one of the biggest quarterly slides on record.
In an era when demand shocks are becoming the dominant fear, it is no wonder that oil traders are wary of a repeat.
