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Risk Rising In Oil Markets → Coronavirus vs. Katyusha Rockets - 1 31 2020 8 33 19 AM

China and Oil Demand Continue to Plague Oil Markets But Keep Eye on Mid-East Geopolitical Risk

With due apologies to Copernicus, China is once again at the center of the oil markets universe. 

For most of 2019 oil prices took a beating because of oil demand concerns resulting from the US-China trade war.  A phase-one trade deal and deeper OPEC cuts gave oil prices a lift at the beginning of 2020 but just like whack-a-mole, China demand issues are front and center with dire news of the spread of the Coronavirus.

The machines are modeling Coronavirus with a comparison to the SARS impact on economic and oil data, which turned aggressively bearish following the 2003 outbreak. For oil markets, the SARS and Coronavirus outbreaks have the most risk for jet fuel demand. Our friends at IEA report that jet fuel consumption in China is nearly double the percentage of total consumption from 2003.

Still, in our view, the dive in oil prices from China demand concerns are overblown at this point. We think it’s likely a short term situation that China is throwing massive resources at amid real concerns about its own economic growth.  In addition, we are told the US is readying extensive assistance to China to combat the Coronavirus. It seems both Trump and Xi have the same urgent goal to keep their economies growing in 2020.

But for now, Coronavirus is casting a huge shadow on oil demand and the global macro-economic picture. And you can’t argue with the data.  Hedgeye’s own macro process shows data potentially signaling a move from Quad 3 (long oil) to Quad 4 (short oil). The macro team suggests closely watching oil volatility sustained above the critical phase level of 38 as a sign that a transition to Quad 4 may be in the works (USD strength is also a problem for oil).

Katyusha Rocket Risk – Don’t Forget Iran Proxies

However, Coronavirus is not the only game in town. In our view, geopolitical risk remains sky high as news of a Katyusha rocket attack at the US Embassy compound in Baghdad this week demonstrates.  The rocket attack received little news coverage, mainly due to very limited damage to vacated buildings at the embassy.   But the attack is a reminder that there remains tremendous risk from Iran’s proxies in the region.

On Wednesday, we learned that Houthi rebels launched rockets at the Aramco refinery complex in Jizan on the Red Sea last week.  The rockets were shot down with no damage to the facilities but it’s another example of continued risk in the heart of the oil producing Middle East.

Oil markets have faded any continued geopolitical risk between Iran and the US after Trump took a pass on responding to Iran’s missile attack at the US-occupied Al Asad air base in Iraq. 

There is not much you can say for sure about oil markets but we think it is safe to assume calm waters will not endure in 2020 – especially stemming from the US-Iran conflict.

General Dan Christman, our Hedgeye colleague who advises on geopolitics issues, expressed the same concerns in a recent client note. “Iran may be restrained over the near-term by a now-clear US red-line, but don’t expect Iran’s proxies to feel that same sense of moderation – especially those based in Iraq and led formerly by [the late Abu Mahdi al-] Muhandis,” Christmas wrote.  He added that the Iranian shoot-down of the Ukrainian airliner “demonstrated yet again how a single event in this region can quickly change international narratives.”

On top of geopolitical risk, add OPEC’s next move.  To be sure, the OPEC+ group will not let oil prices dive without a fight. At a minimum we are looking at an extension of the deeper cuts enacted in December to at least June but we think additional deeper cuts are under active consideration. OPEC’s next meeting is scheduled for March 5-6 but there is new talk of moving up the meeting to February.

Coronavirus is dominating the oil market universe today but forget Katyusha rockets at your own risk.