There have been many economic victims to COVID-19 around the world, and arguably one of the biggest has been the global oil market, which has crashed into negative territory for the first time in history. We spoke to Peter Kiernan, Lead Analyst for Energy at The Economist Intelligence Unit, about the price crash, and about some of the longer term implications for energy markets around the world.
With the massive drop in global oil prices, what are some of the downstream impacts you expect to see in energy industries around the world?
The current oil price crash is a function of both collapsed demand and oversupply, which makes this latest scenario a little unusual. The price crash of 2014 was mainly a supply story, the one before that, in 2008-09, was about demand. But this time we have demand collapsing because of COVID-19, while key exporters decided in early March to fight a battle over market share. This was a recipe for disaster for oil prices.
As a result refineries will have to cut runs in the face of collapsed demand, upstream operators will have to make drastic cuts to capital expenditure, and proposals for key infrastructure projects, such as LNG projects, will be put on hold (if not yet with an FID).
If producers do not cut supply quickly enough, stocks will build rapidly and global storage capacity will be reached, forcing them to cut back on output. This is because the demand is not there to take barrels and no-one has anywhere to put them.
However, this is quite disruptive to the industry, as shut-ins are costly for producers, while downstream players are affected as well, in refining, distribution, and storage.
What do you expect to happen with global LNG prices in response to COVID-19?
Natural gas prices have been falling, although they have already been weak, especially in the US, where natgas is trading at less than $2/MMBTU. Prices in Europe and Asia are under pressure as well. Oil-indexed LNG prices will fall, narrowing the difference with spot prices, thus there will be pressure on exporters, such as Australia.
The impact of this is that proposed projects for liquefaction capacity expansion are likely to be delayed, especially where such projects are more expensive, such as Australia and Canada. Some mooted projects in the US will be taken off the board as well.
What do we need to see globally to see oil prices lifting again?
Because the contraction in demand is so severe, and could be as much as 20-25 million barrels per day, which is 20-25 per cent of total demand, it will take very severe supply cuts to lift prices sustainably above $40/bbl. For that to happen, demand will also have to recover, but this is unlikely until the second half of this year. Therefore OPEC exporters, Russia and others would need to collectively cut output, and this includes the US where doing so is difficult from a regulatory angle.
Once storage capacity is reached, producers will have to shut in production, which eventually will have a price impact. Even without a mandated cut, US output will contract this year as prices are too low for shale producers to continue growing output. Eventually the market will play its part if mandated cuts are not enough to restore balance between supply and demand, but there will be a lot of disruption along the way.
Will there be any winners in the energy industry as a result of COVID-19?
There are no winners, but some will lose more than others. In an environment of demand destruction, higher cost producers will suffer more, such as the US shale sector, Canada and Brazil, while lower cost producers, such as Saudi Arabia, can expect to weather the storm better.
This is probably what the Saudis banked on in early March, but it is likely they did not appreciate the extent to which demand was going to collapse. Otherwise, oil producers that depend less on oil revenue for their economic health will not lose as much those that are more dependent, although most in OPEC are in the latter category.
What changes to global energy demand do you expect to see as a result of COVID-19?
This is an unusual situation as the demand contraction has been caused by the necessary response to the devastating COVID-19 outbreak. Travel bans, stay at home orders, flight cancellations, lockdowns, shut downs of non-essential industries and disruption of supply chains have all been the norm.
Oil prices have collapsed, and theoretically this is good for the consumer, but it matters little when economies are in lockdown and people can’t drive or fly, shops are closed or factories closed.
It remains to be seen whether this will have a long term impact on consumer habits in terms of fuel consumption, but it is worth noting that air quality has improved during this crisis in many cities, and this may not be forgotten when the world emerges from this global health crisis.
Do you think the crisis will cause importing countries to start to look at the security of these arrangements, and potentially renewable alternatives that could make them less reliant on imports?
While low prices are good for huge oil-importing economies, such as China, Japan, and several in South East Asia, they are still subject to the volatility of oil and gas price swings, and those that have the resources to do so will continue to make efforts to limit oil consumption growth (China and Japan).
Importing economies may also use this opportunity of low oil prices to cut back on fuel subsidies, which many did last time. I think that exporters face a dilemma, in that the oil market seems to be in short term turmoil while it faces a longer term existential crisis, and that is of peak demand.
They will therefore need to inoculate their economies from over-dependence on fossil fuel exports, and diversify, which will make their economies more resilient in the long term.
What impact will the pandemic have on exploration and development in the energy industry around the world?
Upstream players will cut back on their capital expenditure budgets, and this means less spent on exploration and production for the foreseeable future. It will take some years before we see the effect of this, but clearly the majors, such as ExxonMobil, and others, such as the smaller shale players, have already made big cutback announcements for 2020, as you would expect given the sharp crash in oil prices.
Eventually as oil prices recover this will change, but we must remember that this is the second price crash in five years, and the last price crash resulted in expenditure cutbacks as well. The US shale sector, for example, will find that the willingness of the financial sector to fund its activities will ease off, which has implications for shale’s future growth potential.
Oil and gas majors may find that investments in other sectors, such as clean energy technologies, which offer lower but more stable returns, might be worth a bigger think.