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Market structure weakens as analysts mull impact of omicron variant on oil demand

Highlights

Crude has fallen by more $13/b on new COVID-19 strain

Volatile forward curves as demand fears grow

Oil demand growth of just 2.9 mil b/d in Platts Analytics variant scenario

The oil market is drastically trying to assess the impact of the COVID-19 omicron variant which threatens to derail the demand recovery.

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Analysts are still mulling whether to revise their 2021 and 2022 demand estimates as many insist it is too early to make any dramatic changes to their outlooks.

But the futures market is already spooked by the news, with oil prices having plunged more than $13/b since news of the new coronavirus mutation.

At 1748 GMT, the ICE January Brent futures contract was down $2.94/b from the previous day's close at $70.50/b.

The steep backwardation on a variety of oil forward curves has also flattened steadily, another sign that the market is worried demand could take a significant hit after a strong recovery in the past few months.

But the consensus is that the aviation sector, and therefore jet fuel demand will be the worst hit sector, and renewed lockdowns in some parts of the world are likely to dampen demand this winter.

Demand doubts

S&P Global Platts Analytics said the omicron variant could potentially temper oil demand growth to as low as 2.9 million b/d in 2022 compared to its base case of a demand growth of 4.8 million b/d.

The most likely impacted metric will be international flights, followed by domestic flights and then mobility, it said in a recent note.

"On the aviation front, for every reduction of 10,000 flights flown, global jet fuel demand would be reduced by 600-700,000 b/d, according to Platts Analytics.

Ole Hansen, head of commodity strategy at Saxo Bank said it was too early to make any dramatic changes to the 2022 outlook.

"No doubt that there will be an immediate negative impact on jet fuel demand with Asian refining margins having already dropped to their lowest in more than two months," he said to S&P Global Platts.

"Renewed lockdowns would be a major gamechanger but for now governments around the world will do whatever it takes to keep their economies open."

Hansen however said that the energy crisis in Europe and Asia still lingers on, and this could easily make up for the loss in demand elsewhere due to gas to oil switching.

Some analysts said the sharp drop in oil prices since Nov. 26 was because prices weren't totally reflective of current market fundamentals.

Paul Horsnell, the head of commodities research for Standard Chartered bank, said the price drop was due to "the deflation of a bubble created by overstatements of market tightness."

"The market needed the expectation of something large enough to stop any push on to $100/b, stop the super-cycle talk and to start to price in some already fairly weak Q1 balances," he told Platts.

"Omicron effects look likely to be big enough to do that, and that's enough to make $70/b look fully priced. So it was more about deflating the bubble than measuring the precise size of the needle that made the puncture," added Horsnell.

Flattening structure

Worries that the current vaccines could be ineffective against this new variant is pushing many to assume there will be a fall in oil demand.

But the oil market derivatives are already experiencing a high level of volatility.

The Nov. 26 omicron-led crash did not soften the steep backwardation between prompt months of either ICE Brent futures or Cash Brent-Forties-Oseberg-Ekofisk-Troll (Cash BFOE) derivatives contract. on the day. But, with renewed selling pressure Nov. 30 and the expiry of January Brent contracts due, structure flattened and even snapped into contango in parts. The effect was clearest in contracts linked to physical markets.

A reported January/February Cash BFOE trade indicated a 10 cent/b contango between the two months, a contraction of over $1/b from Nov. 26, while Dated to Frontline swaps contracts –- which provide a link from futures to Dated Brent -- swung into a sharp contango in prompt months.

In a contango market, the forward price of oil is above the prompt price, implying weak prompt demand and growing oversupply, encouraging storage.

Contango, which is the opposite of backwardation, is normally considered a key indicator of a depressed oil market, and oil traders have to store oil on land or ship to cut risks.

Spreads between big name crude markers like Platts Dated Brent and Platts Dubai and WTI yo-yoed as the market adapted to the shifting outlook. Notably, Brent's premium over Dubai collapsed to around $2/b from premiums of more than $4/b in the week to Nov. 26.

With these spreads much-watched markers among traders for arbitrage opportunities, the market may see shifting trends in global oil flows in coming weeks

Similarly, the refining sector has also reacted negatively to the news, with northwest European crack spreads and refining margins falling sharply.