New COVID Variant Causes Oil To Plunge As Demand Picture Clouds

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New COVID Variant Causes Oil To Plunge As Demand Picture Clouds

Oil futures plunged Friday on news of a new Covid-19 variant, with global benchmark Brent crude down nearly 12% — its steepest drop since April 2020 at the peak of Covid-19 pandemic and worldwide lockdowns.

In London, Brent crude for January delivery was down $9.50 at $72.72. In New York, January West Texas Intermediate (WTI) on Nymex was down $10.24 at $68.15 — a 13% drop.

Oil products markets were also a bloodbath. NYMEX December gasoline was down a whopping 18.98¢ at $2.1299 per gallon, with the diesel contract down 20.31¢ to $2.1799/gallon. However, it could take several days, even weeks, to filter through to pump prices.

Broader financial markets were also deep in negative territory, with equities selling off hard and risk sentiment evaporating.

Traders and market watchers placed the blame squarely on the new Covid-19 variant, named Omicron, which has emerged in southern Africa and shows signs of being more transmissible and difficult for the immune system to fight off. 

Although there has only been a minimal number of cases of Omicron, it has been described as the worst variant seen so far by experts, which is significant coming off the delta variant. 

There is concern that it can evade immunity and could lead to rampant new lockdown activity, which could put a big dent in oil demand when markets were already expecting a seasonal slowdown in the first half of 2022.

International flights had just begun to resume, but global jet fuel demand outlook is now cloudy again. The UK has already put several southern African countries on its travel red list. Fears that more countries will introduce fresh lockdowns and travel restrictions are pounding crude.

The new variant has thrown forecasts of oil market fundamentals into disarray, overshadowing recent news of releases from strategic stocks from large consumer nations and concerns over OPEC and its allies’ response.

Coronavirus is overwriting even the most pessimistic forecast on the immediate oil balance and injecting significant new volatility in the market. 

The initial reaction implies that a new layer of uncertainty has surfaced, and its longer-term impact is anything but unambiguous. That said, the timing of the variant’s emergence and detection may have exacerbated the downward move in oil prices.

The Friday after Thanksgiving — a public holiday in the U.S. — is notorious for light trading volumes, resulting in exaggerated price movements. 

Markets may be running ahead of themselves on the variant. We’ll know more early this week when human traders return, and market decisions are not left to algorithms and low liquidity, which dictated much of the action on Friday. Post-Thanksgiving sell-offs have emerged as almost routine in recent years, but this is hardly routine.

The big question now is how the OPEC-plus group responds. The group is due to meet this Thursday. It had been previously focused on how consumer-focused releases from the Strategic Petroleum Reserve (SPR) affect balances and whether to adjust supply lower in response.

Before Friday, the OPEC cartel had already predicted an oil surplus would grow after the United States and other major consumers decided to release oil stocks to help cool down prices.

OPEC-plus has been releasing 400,000 barrels a day of oil per month while winding down its record cuts from last year when it cut production by as much as 10 million barrels a day to address lower demand caused by the virus lockdowns. OPEC-plus still has some 3.8 million barrels a day of cuts still in place, and the group could pause with the increases after the release of SPR oil and possible repercussions for demand from new lockdowns to contain Omicron. 

OPEC-plus does not want to lose control over this market, so it could make sense to pause the increases. The group schedules regular monthly meetings to determine supply policy just for this reason — this is another reminder that the post-pandemic oil market is challenging to manage.

The sharp drop in prices — if it holds— is good news for consumers and the Biden administration, which has been seeking ways to curb rising oil prices and inflationary pressures in the economy. 

American producers are currently fixing 2022 capital budgets, and the price plunge and uncertainty may encourage more caution in spending plans.

After years of cost-cutting and capital discipline, U.S. producers are still profitable at WTI prices of $60 to $70 a barrel. Their 2022 growth plans should remain solid. It’s too soon to say how any of this will shake out. But it shows that the coronavirus continues to be the biggest wildcard in markets despite increasing vaccination rates. 

Some experts like Goldman Sachs
GS
say the oil market overshot with the selloff on Friday. It thinks OPEC-plus will fix the problem by pausing supply increases for three months, which could put crude back on the path toward $90 a barrel. 

Long-term, the issue of underinvestment in global oil supplies remains a concern, and most see tight markets in coming years as a result. But Covid-19 remains the ultimate demand-side wild card, as Omicron has reminded everyone.

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