Delta Variant
Delta is the name for the B.1.617.2. variant, a SARS-CoV-2 mutation that originally surfaced in India. It hit India hard in May / June. At one point during the peak India was recording ~300K new cases every day (and the actual number was likely far higher)!
By the end of June, the wave in India had subsided but almost half a million people died (some estimates of >1mm deaths) and the virus started spreading all over the world, with some developing countries like Indonesia hit particularly hard and even developed countries like the UK, with ~50% of the population fully vaccinated, seeing a fourth wave of cases (though far fewer hospitalizations and deaths compared to prior waves).
What makes Delta particularly dangerous is the high R0 of around 6-8 (each infected person spreads it to 6-8 people) and the fact that the mRNA vaccines most commonly deployed in the first world are only 60% effective against it (vs. 90%+ effectiveness reported in the Phase 3 trials). The other bad news is that data from Israel is showing a pretty significant drop off in vaccine efficacy 4 months after getting fully vaccinated.
However, the good news is that the same data shows vaccines remain highly effective (90%+) at preventing hospitalizations / severe outcomes.
The UK data on hospitalizations also confirms this.
The problem is that despite everything governments are doing to encourage people to get vaccinated, the vaccination rates seem to have plateaued at around 50% for a number of the major developed economies.
While the wave in the UK appears to be subsiding, cases are starting to rise in the US. The recovery in US economic growth and mobility has been the biggest tailwind for oil demand the last couple of months so this is something to watch carefully if you’re playing the energy sector.
States like Florida in particular are a big concern given the low vaccination rates. Hospitalizations in Florida, particularly for younger people who are mostly un-vaccinated, are already higher than the previous waves.
The overall picture is therefore mixed: on the one hand the UK and Israel data show that the vaccines remain effective against hospitalizations and deaths. However, with vaccine efficacy waning over time (esp amongst older adults who were vaccinated earliest) and vaccination rates plateauing, there is a significant risk of an uptick in hospitalizations and deaths in the US that could force policy makers to re-evaluate re-opening plans. Mask mandates are coming back and some States might start considering lockdowns if ICU capacities reach critical levels.
These decisions will likely be made at the State level given the disparity in vaccination rates between States, but rising case numbers will regardless be a headwind for oil demand as people will likely restrict their mobility out of their own choice / risk-averseness. International air travel recovery has already taken a hit due to the variant spread.
Conclusion: the next few weeks, months are critical. It appears the delta variant wave in India has finally died down, and the UK appears to be on the mend. However cases are rising exponentially in some other Asian countries like Pakistan, Indonesia etc. and most importantly (from an energy market perspective), starting to rise in the world’s largest oil consumer, the US.
In the absence of restrictions, there is a significant probability that unvaccinated populations and people who were vaccinated earlier in the year in the US will see a rise in deaths and hospitalizations which could put strain on the healthcare system and could impact oil demand.
There is an additional tail risk that I believe should also be considered. With vaccinated people now being infected, there is an increasing risk that the virus could mutate to form a new vaccine-resistant strain. While this remains a small probability at the moment, the longer the Delta variant continues to circulate and cause break-through infections (infections amongst vaccinated people), the higher the chances of this happening. The current situation is a race against time and unfortunately a lot of countries’ vaccination rates are still significantly behind what is needed to prevent these outbreaks turning into full-blown infection waves.
Considering all of the above, appropriate risk management dictates that any leveraged bets on oil or oil equities (options etc.) be taken off. I’m personally holding on to my core positions in Gear Energy and XEG, but I have sold out of my trading positions in XOP call options. Now is a good time to have some cash and watch how things unfold from the sidelines.
The Pale Blue Dot 