The ‘Black Swan’ Event That Could Unravel OPEC’s Efforts

The book “The Black Swan” was written by former Wall Street trader Nassim Nicholas Taleb to describe rare, outlier events that can’t be predicted beforehand, but that have potentially huge consequences.

The phrase “black swan” has been used to describe any number of financial events, such as the 1987 stock market crash, and the 2008 financial meltdown in the housing market.

The thing to remember about black swans is that by their very nature, you never know when they are going to pop up. Although the oil markets have been hit by virus-induced demand fears in the past, such events are black swans.

Currently, the spread of coronavirus in China — the world’s largest oil consumer — is a black swan that has the oil markets reeling. Oil fundamentals looked fair a month ago, but now all bets are off. Oil prices have shed nearly 20% in four weeks, but it’s hard to say where the bottom may be with coronavirus cases still growing.

Citigroup analysts have suggested that the virus could reduce oil demand by 1 million barrels a day (BPD), but this is still clearly a developing situation.

As oil prices fell in January, OPEC was widely expected to debate additional production cuts at its March meeting. However, in the face of the most significant demand destruction the world has seen in more than a decade, the cartel tried (and failed) to get an agreement with Russia on deeper production cuts.

Jay Park, the CEO of oil company ReconAfrica, emailed me his thoughts on the ultimate impacts, which he believes are mostly already priced in:

– “We expect to see a drop in refined fuel demand markets out of China in a matter of days or weeks. A quarter of a million barrels will likely be the ultimate impact, which, all things considered, should be modest. There are five factors that affect oil pricing supply, demand, OPEC, geopolitics, and sentiment. Regarding the coronavirus, this seems to be an issue mostly related to sentiment. Demand concerns and OPEC can compound this situation, and it is something we are monitoring, but any movement right now is being driven mostly by fear. For perspective, we’re looking at past situations, like the SARS outbreak in 2003, which showed us that the impact from the outbreak was small on demand overall, but the decline in price was significant.

– We see the impact of the virus on price could be about a drop of $5-$10 a barrel in Brent and WTI. I see the coronavirus impact as already priced in, as we have seen WTI go from $63 to $53 and Brent from $68 to $59 this month. There are other bearish factors also at work, such as new production in Guyana, the perception of some weakness in demand overall in the global economy, and a seasonal reduction in demand that normally occurs this time of year. Add the coronavirus, and that becomes another issue we have to be on the lookout for. But let’s also bear in mind that similar illness-related price declines have had an impact for a limited period of 2-6 months.”

Meanwhile, one of my January predictions was that the price of West Texas Intermediate (WTI) wouldn’t close below $50/bbl this year. I felt pretty good about that prediction a month ago — before anyone had died from coronavirus — but that prediction is going to fall as fears of Chinese demand destruction grow.

That’s the other thing to remember about black swans — it’s hard to predict how big the ultimate consequence will be until the event is over. This one seems far from over.

Source: oilprice.com

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