February 3, 2020/InvestmentOne Report

Announced on 31 December 2019, Novel Coronavirus (2019-nCOV) has since spread across 24 countries with 14,557 reported cases and 305 recorded deaths. The outbreak of this virus has led to a slowdown in economic activities, and with China being one of the largest oil consumers in the world (largest oil importer in the world), oil price has, for the last two weeks, lost c.13% (currently trading at US$ 56/bbl). 

Taking a cue from a related virus outbreak in 2003, SARS coronavirus (SARS-CoV), we try to examine the impact of the Novel Coronavirus on oil price and possibly, a potential devaluation in Naira. It is worthy to note that, although the severe acute respiratory syndrome (SARS) virus shares some similarities with the 2019-nCOV, they are different in two ways: Fatality and Rate of Transmission. While the SARS virus is more severe with slow dispersion, the 2019-nCOV is less severe with fast dispersion. In the SARS outbreak in 2003, which spanned for about 9 months spreading across 26 countries, they were about 8000 cases recorded with a fatality rate of c.10%. However, within one month of its outbreak, the Novel Coronavirus has already spread across 24 countries – with a fatality rate of c.3%. 

So what happened in 2003? 

The outbreak of the SARS virus in 2003 was greeted with an unresponsive Chinese Government as they concealed this information from its own people, the World Health Organisation (WHO) and the world at large; the epidemic would later continue for about 9 months, ending July 2003, with the first case recorded in November 2002.  

Oil price within that period lost about 20% dropping from a peak of US$33/bbl to US$27/bbl, despite the tensions in the Middle East that consisted of the US invading Iraq in a storm of mendacious pro-war rhetoric. 

Three points are useful in this case and serve as a pointer to what we should expect in this year’s outbreak:

1.    The response of China to the virus outbreak – comparing 2003 and 2020.

2.    The rate of spread of Novel coronavirus compared to SARS coronavirus

3.    Tension in the Middle East 

What do we know about Novel Coronavirus? 

The WHO has declared the outbreak a global emergency issue and all hands are on deck to find a cure to this virus (no treatment currently exists for SARS except supportive care). The treatment of this class of virus is dependent on the success of treating its symptoms. The danger of this epidemic, although not so fatal, is the rate at which it spreads. This has a negative effect on economic activities and oil price is not excluded. In 2003, China’s daily consumption of oil was 5.5mbpd; this was a consumption of c.8% of total oil production (67.1mbpd) . Today, China consumes about 13.5mbpd, representing a consumption of 16% of total oil production (80.6mbpd as at December 2019). For us this means that the threat to oil price is seemingly higher now than in 2003, as China world’s dominance has significantly improved. 

Pressure on Oil price – A Possible Devaluation? 

Although oil price declined in 2003, following the outbreak of the virus, it managed to close the year positive. According to the OPEC 2003 annual report, the annual average price of the OPEC Reference Basket rose by $3.74 per barrel on a year on-year basis, to average $28.10/bbl. Despite the impact of the outbreak of SARS in Asia that kept energy markets unsettled throughout the year, the threat of a US-led invasion of Iraq in the early part of the year, oil workers’ strike in Venezuela, OPEC production cuts among other factors kept prices strong in a backward market. 

However, the situation today is markedly different from 2003. Our points are embedded in the three points earlier mentioned, and China’s dominance as a consumer in the global oil market. 

·         China’s response to the outbreak of 2019-nCOV is different from its response in 2003. Unlike 2003, the Chinese government has willing shared information about the virus with the WHO and the world. As a result of this, the WHO has been able to identify the cause of the virus, declare a global world emergency and invest funds on the creation of a vaccine that could help prevent and treat the virus. This for us means that, the world may have a better chance of curtailing the virus – possibly before lapsing the timeline of 9 months (as in the case of SARS).  

·         However, a downside to this is the rate at which the virus is spreading. In just a month, the 2019-nCOV has surpassed the rate of dispersion of the SARS virus in 9 months. This rate of dispersion is highly critical to the movement in oil price as analyst and traders are more concerned about how this will limit business activities. Consequently, we believe that, if the rate of dispersion is not curtailed in the near term, it will pose a major threat to oil price. Furthermore, measures to curtail its spread has also led to a decline in economic activities as well as demand for oil as governments are cancelling flights, shutting down cities and closing borders. 

·         Although geopolitical tension in the Middle East remains, it seems to have considerably subsided compared to the case in 2003. With the US President releasing a Middle East Peace Plan – although rejected by Iran, Iraq and Syria, we think tensions may remain at low levels. Furthermore, the oil market has since factored in the losses of oil production from Iran, following the US re-imposition of sanctions. How much more oil can be lost in these tension prone areas? 

·         As stated earlier, China’s oil consumption has grown faster than growth in oil production. Consequently, the economy consumes about 16% of total oil production in the world. Combine this factor with a fast spread of the virus, a potential decline in economic activities and oil demand will send oil price nosediving. Recall that in 2003 when China consumed 8% of total oil produce, oil lost 20%. 

What does this say for Nigeria? 

The factors on ground suggest that there is a significant threat on oil price declining further (currently below FG’s budget benchmark of US$57/bbl). This is majorly dependent on how soon the virus can be contained and how soon economic activities in China return to normal levels.

Although the CBN governor, Godwin Emiefele, has stated that there will be no devaluation in the Naira except crude oil price drops to U$45/bbl and FX reserves drops to US$30 billion, we believe pressures from novel coronavirus – if sustained, constitutes a bigger threat. At this point, we become increasingly concerned about the CBN’s ability to maintain currency stability in the face of this epidemic. In the event that the virus continues to spread, it will not take long before oil price declines briskly and foreign investors start considering investing in safe havens – triggering foreign outflows and rapid decline in FX reserves.

 Follow the link for medical information (prevention) and update on the novel coronavirus: https://www.who.int/emergencies/diseases/novel-coronavirus-2019