Predicting oil prices has always been a mug’s game, and betting right in today’s market has proved especially difficult, even impossible, because of the arrival of a dreaded Black Swan event.
A Black Swan is the argot used by traders and risk managers for an unforeseen event that comes out of nowhere and has severe or potentially severe consequences. That event was the coronavirus outbreak in Wuhan, one of the biggest cities in China, which is now under quarantine.
The virus, by Thursday, has been responsible for 17 reported deaths and some 550 confirmed cases, and the numbers are expected to rise.
The outbreak has triggered a rapid fall in oil prices, in good part because flights to and from China will be curtailed, hurting demand for jet fuel.
Before the first coronavirus case was reported at the end of December, Brent crude, the international benchmark, was trading at about US$69 a barrel. On Thursday afternoon European time, the price fell to US$63.50 – down a hefty 2.7 per cent from the previous day – after steady declines since the weekend.
As the virus spreads – cases have been spotted in Japan, Taiwan, South Korea, Thailand and Washington State – only the exceedingly brave or foolish would bet that prices have bottomed out.
Just last week, prices were ticking up, in part because General Khalifa Haftar, the eastern Libyan warlord whose forces launched an assault on Tripoli last year, choked off Libyan oil production and exports by shutting down the big pipeline that leads to the coastal city Zawiya. Prices reversed when the news trickle about coronavirus turned into a flood, spooking the energy markets.
“For Libya, the risk was known and therefore already priced into the futures market,” Olivier Jakob, managing director of Swiss oil trading advisory firm Petromatrix, told The Globe and Mail. “Libya has been partially taken into account in the futures. But China is a full surprise; Libya is not.”
He said that traders fear Black Swan events because their impacts are impossible to predict. No one can say today whether the coronavirus spread has peaked or is just getting started.
Previous outbreaks of epidemics can provide some guidance, but only some. The outbreaks of Ebola (mid-2014), H1NI (late 2014) and Zika (late 2015) were all instrumental in pushing down oil prices within weeks of the first reported cases. According to Raymond James oil analyst Jeremy McCrea, the epidemics saw West Texas Intermediate, the American benchmark, fall between 7 per cent to 13 per cent. Those are big drops.
The spread of coronavirus appears to be warping the refinery market too, Mr. Jakob notes. If Chinese domestic demand for refined products falls – remember, Wuhan is under quarantine – those refiners will naturally try to fill the void by ramping up exports. That may already be happening. More exports will put downward pressure on the prices of refined products, which in turn will put pressure on profit margins.
The fall in oil prices comes at a bad time for American energy companies, especially those in the shale industry. Many of those companies are struggling with high debt, and the oil slump is pushing some over the edge. The Financial Times, citing data from the Texas law firm Haynes and Boone, said that 50 energy companies have filed for bankruptcy in the first nine months of 2019, most of them oil and gas producers and oil field services companies.
How will oil traders and energy investors protect themselves from the coronavirus nightmare? They can’t, really, for the simple reason that Black Swan events don’t play by any rules.