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    Markets Shift from Bad to Worse as Covid-19 Spreads

Summary

The epidemic has weighed down on already low oil and gas prices.

by: Joseph Murphy

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Markets Shift from Bad to Worse as Covid-19 Spreads

The coronavirus epidemic (Covid-19) has weighed down on already low oil and gas prices, while also putting upstream projects at risk of delay. It has exacerbated the global LNG supply glut, raising questions about where this cheap gas will go.

Oslo-based Rystad Energy has slashed its forecast for Brent in 2020 to $56/barrel, it said in a research note on February 27, from $60 previously, and warned that a another negative revision might be around the corner. 

Brent hit a 12-month low on February 26 of $53.4/b, amid concerns about the continuing spread of the outbreak, which health experts warn is on the verge of becoming a pandemic. Rystad estimates that the virus' net impact on oil demand could result in the same surplus of oil supply in the second quarter as in the first.

The surplus could reach 1.8mn barrels/day, Rystad warned, if there are no further production cuts and assuming output in war-torn Libya returns to normal in the second quarter. Thus far the Opec+ group has not responded to the crisis, largely because of resistance from Russia, which is part of the 'plus'. Oil ministers of the suppliers' alliance are due to meet in Vienna on March 6 to discuss policy, Reuters reported last week.

The epidemic has had a similar impact on gas markets. The industry struggled with global oversupply of LNG last year, as a result of supply additions exceeding demand, resulting in record low gas prices in Asia and Europe. The virus has made a bad market situation worse.

China – the world's biggest LNG importer – has been calling forces majeures on some of its purchase contracts, in response to weak demand. Preliminary data indicates that Chinese gas demand contracted yr/yr in January for the first time in at least two years, by 1%, and Rystad earlier cut its forecast for full-year growth in Chinese LNG demand to 4.7%, from 10-13% previously. 

Highlighting the strain companies are under in Europe, the head of Austria's OMV Rainer Seele said in interviews earlier this month he was praying for an ice blizzard  to prop up prices. Rystad now sees gas prices in Europe averaging below $4/mn Btu this year, after cutting its forecast. Dutch Title Transfer Facility prices are now expected to be at $3.95/mn Btu, it said, versus a $5.56 forecast it made in January.

The consultancy has likewise slashed its prediction for Asian spot prices to $4.63/mn Btu for 2020, from $6.32 previously. US Henry Hub prices are slated to average $2.26/mn Btu, versus $2.55 before.

Europe was key in absorbing cheap extra LNG supply last year, but there are doubts that the market can perform the same role again.

"There's a lot of cheap LNG floating around, and I'm not sure exactly how things are going to shape up in Europe; but the growth in LNG imports will slow for sure," Mitch Jennings, analyst at Sova Capital, told NGW.

And in its annual LNG outlook published earlier this month, Anglo-Dutch major Shell, the world's biggest supplier of freely-deliverable LNG, warned that this could be the year that sees liquefaction plants being shut in. New supply added 40mn metric tons (mt) to the market, a record amount; this year another 20mn mt are due to arrive and next year, another 10mn mt/yr.

Shell, like other majors, has been protected from the worst effects of the glut by oil indexation in the LNG sale contracts. It sells about four fifths of is cargoes at crude-based prices. But $54/b translates into only about $6/mn Btu, at an 11% slope.

Good news for the environment?

The upside is that low gas prices should encourage more coal-to-power switching, which Rystad expects to increase by 6% in northwest Europe.

"Europe is reaching a limit on how large additional gas volumes it can take, as Russian volumes remain high, storages are full, and temperatures stay mild," Rystad analyst Carlos Torres-Diaz said in a statement. "Asian buyers should take advantage of the price slump to import higher volumes of a cheaper and less carbon-intensive fuel than coal."

The CEO of Vitol, Russell Hardy, told the IP Week conference in London February 26 that low LNG prices will help to create demand but building infrastructure to mop it up will take one or two years. Thereafter though Asian demand could reappear, and even if it is only slightly short of supply, there could be a big enough arbitrage to draw US LNG: $5-6/mn Btu for deliveries ex-ship in Asia, compared with Henry Hub below $2/mn Btu. But, he said, it would take more than $3/mn Btu delivered price to trigger upstream gas development. He also pointed out that the areas hit in Italy were in the north, the country's major economic hub. 

Project delays

For oil and gas producers, the epidemic means project delays, as a result of manufacturing shutdowns and shipping bottlenecks. But the effect of these delays pales in comparison to that of low prices on companies' finances.

"For most operators, even if delays stretch to six months, the greatest impact is prevailing oil and gas prices," Fraser McKay at Edinburgh-based Wood Mackenzie commented. "We calculate a $10/barrel change in price (the pull-back in Brent since January) has a $40bn impact on global cash flow per quarter. For some companies, this could make the different between increasing shareholder distributions or another year of negative cash flow."

WoodMac estimates that projects with a combined peak capacity of 1.5mn barrels/day of oil and almost 4bn ft/day of gas are at risk of delay.

"If delays do occur, an average of three months would only reduce 2022 production (the peak year of impact) by 160,000 barrels/day," McKay said.  "A mere scratch on the surface of global supply. But if control of the disease takes a turn for the worse, the impact multiplies quickly."