Delta variant may stoke oil demand and price reductions

The World Bank (2020) notes that the outbreak of the COVID-19 pandemic and the wide-ranging measures needed to slow down its advance triggered an unprecedented collapse in oil demand and a record one-month decline in oil prices in March 2020. Coupled with the collapse in global energy demand, was the alarming rate of global inventories build-up, which rose sharply amid times of limited storage capacity, as found by the International Energy Agency (2020).

The relationship between demand and supply, which buffeted oil markets and culminated in the plummet of oil prices, was not unexpected as the measures deployed to contain the virus including quarantines, travel restrictions, shutdowns of non-essential activities were certainly ripe to cause economic dislocations.

The precipitous decline in oil consumption in the context of still-robust production led to a rapid build-up in the oil inventories bringing the remaining storage capacity close to capacity by the first half of the year.
In the earliest parts of the pandemic, oil prices plummeted substantially, recording its largest one-month fall on record in March the same year on 2020.

In one instance, the spot price of the European Brent fell by 85 percent between January 22, when the first human-to-human transmission of the virus was detected and announced, and April 21, according to World Bank’s record. These staggering revelations were more than the recorded fall in prices at the height of the global financial crisis of 2008 where prices fell by 77 percent from end-August to late-December 2008. They were also higher than the plunge recorded during the whole period of end-June 2014 to mid-January 2016 when prices fell by some 77 percent.

It must be stated that within the year 2020, the West Texas Intermediate (WTI) oil price fell into the negative territory on April 20 (World Bank 2020; OilPrice 2020).

Analysts all around have attributed the fall in prices to the global pandemic and the restrictions on business and personal activities that were imposed as necessary measures to stem the spread triggered the global recession and the resultant steep drop in the demand for oil.

Recent Price Rise Attributes

The macroeconomic fundamentals attribute the recent rise in the price of oil to a stagnant global supply and a relational increase in demand from Emerging Markets and Developing Economies (EMDEs) which usually have more energy-intensive production methods than the Organisation for Economic Co-operation and Development (OECD) countries according to Alquist and Gervais (2013). This fact attributes the growth in demand for oil in developing economies to their general economic growth.

The 2020 plunges in oil prices should not come as a wonder as, since 1970, the global economy has experienced seven oil price plunges when oil prices fell by 30 percent or more over a six-month period― 1985-86, 1990-91, 1998, 2001, 2008-2009, 2014-2016 and 2020. Within these periods of price decline, the 1990-91, 1998, 2001, 2008-2009 and 2020 experiences were one-half entirely demand-driven, with the other years’ decline largely supply-driven.

The duration for these previous oil price declines was varied as short-lived periods for those of 1998 and 2001, with oil prices regaining their pre-plunge levels in less than four years. In contrast, oil prices plunge around global recessions of 1990-91, 2008-09, and the largely supply-driven plunges of 1985-86 and 2014-16 were followed by prolonged periods of low oil prices.

In 2020 however, the incidental decrease in oil prices seemed to have cowered to the increased demand when in about a year after the first recorded human-to-human transmission in January 2020, prices had started to bounce back reaching the pre-pandemic levels of over US$60 per barrel by February 2021. The months following were expected to see prices climb upwards due to an expected increase in demand as economies bounced back.

Hamilton (2009) defines the single most important fact for understanding short-run changes in the prices of oil to be income rather than price; the key determinant of the quantity demanded. He shows in his analysis as published in the Brookings Papers on Economic Activity, Spring 2009, that despite the huge fluctuations in the relative price of oil from 1949 to 2009, petroleum consumption followed income grew steadily.

In a more nuanced understanding of events of current times with the pandemic, Hamilton’s characterization of oil demand, which invariably affects prices, reflects the reduced income of many persons around thereby reducing their purchasing power for petroleum products.

This stagnation is ensured and deepened by the extension of restrictions to persons and communities’ mobility who under normal circumstances, will need their daily lives running in order to keep the demand balance up to forestall a fall in oil prices as we have been seeing from the beginning of August.

In most instances, it remains accurate that low prices are likely to provide, at best, temporary initial support to growth once restrictions to economic activities are lifted and until excess inventories are unwound (World Bank, 2020). Once the global recovery was underway from the 2020 plunge on global growth, and the excess inventories were unwound, oil prices were automatically expected to increase in tandem with the expected global economic growth.

These expectations began to see the light of the day when the year 2021 was ushered in and into the first half of the year, many economies around the world experienced some economic growth and a commensurate increase in the prices of oil rising to near US$80 per barrel.

The Delta Variant

Until recently, the global oil price surges fuelled partly by an increased rate of vaccinations against the COVI-19 pandemic spurred confidence in the demand markets that economies were normalizing as people were returning to their usual lives and consumption of petroleum products were rising.

This hope has however been offset by the recent records of increased infection in many countries as a result of the presence of a more transmissible variant of the coronavirus, the Delta variant, a highly contagious SARS-CoV-2 virus strain, which was first identified in India in December 2020. It swept rapidly through that country and Great Britain before reaching the United States (U.S.), where it is now the predominant variant.

By the end of July 2021, Delta was the cause of more than 80 percent of new U.S. COVID-19 cases, according to Centre for Disease Control (CDC) estimates. The World Health Organization (WHO), through its Technical Lead on COVI-19, Dr. Maria Van Kerkhove, has described the Delta variant as 50 percent more transmissible than the alpha, beta, gamma, and the ancestral variant detected in UK, South Africa, Japan/Brazil, and China Wuhan respectively.

The WHO estimates that the variant has reached about 130 countries already with 65 countries as of Thursday, August 5, 2021, reporting a surge in their case count.

These surges are happening in the U.S., UK, Africa, and Asia. This has brought the total number of cases recorded worldwide to over 200 million according to the John Hopkins Hospital analysis of data as of August 4, 2021. Despite the relative success of some countries such as Thailand and Vietnam, to contain Covid-19 cases last year, the Delta variant has caused a sharp rise in recorded cases.

Oil Demand and Price Concerns

The current development is worrying as it invariably means the spread of the Delta variant will weigh down on global energy demand. The increase in the case count for the virus in recent times has caused the prices of the international Benchmark Brent Crude to tumble just as same for the United States (U.S.) Benchmark, the West Texas Intermediate (WTI).

The renewed surge in the cases has resulted in several flight cancellations across Europe, Asia, and the Americas, painting a dark picture of the progress made in vaccinations since the beginning of the year. The Thai Government for instance announced strict curbs, which would be imposed from August 3 to 16 2021 in 29 Provinces, according to Apisamai Srirangsan, Spokeswoman for the Government's COVID-19 task force.

The current demand slump is equally attributed to the imposition of restrictions on movements in many parts of China that has been necessitated by the rising cases of the Delta Variant. In the case of China, the largest importer of oil is worrying as it has the potential of clouding the outlook for consumption, a situation that will hamper the price stability of oil and cause it to fall.

The July 2021, mandatory quarantine measures have already caused several shipping backlogs and dislocations in the marine fuel oil market. The Chinese and American aviation industries have also suffered from several cancellations of flights blamed on the spread of the virus.

The Delta variant spread from the coastline of China to the inland cities is of concern particularly as just about a month ago, the spread of the variant disrupted industrial activities that relied on the supply and use of petroleum products.

In the U.S., the data from the Institute of Supply Management (ISM) revealed that there was a slowdown in U.S. manufacturing factories as it recorded a national factory activity of 59.5 in July down from the June national factory activity of 60.6

Corroborating how these staggering rises in new COVID-19 cases is a cause for concern in the price volatility of oil, Fankel, and Rose (2010) indicates that macroeconomic variables which refer to real global activities like the COVID-19 pandemic and microeconomic variables like inventories of oil in the determination of commodity prices are crucial in the determination of oil prices.

In conclusion, the potential in having the COVID-19 Delta and recently, the Delta-plus variants continuing to cause an increase in the spread of the coronavirus going forward will have a devastating effect on the demand for oils and the price of it.