As Coronavirus lockdowns continue to spread around the world, the oil industry faces more disruption to demand and supply chains, with many margins and prices already collapsing.
With travel and broader economic activity across the world restricted, demand for transport fossil fuels has dropped. This reduction in demand is particularly notable in China, the world’s largest energy consumer, which last year accounted for more than 80 percent of global oil demand. Industrial output and electricity demand and in the country has been functioning at levels far below their usual rate, with coal consumption at powerplants down 36% and the countries’ oil refining capacity reduced by 34%.
For the oil market, the consequence of this reduced demand has been particularly marked, resulting in a twofold challenge, a drop in oil’s value and a consequential price war.
The biggest issue for the industry came earlier in March when the Organization of the Petroleum Exporting Countries (OPEC) and ten other oil producing countries failed to come to an agreement on stable production levels. With Russia unwilling to accept a production cut of more than 1 million barrels per day (bpd) to offset falling demand, oil prices plunged to a multiyear low. By mid-March, crude prices were down to 30%, sparking a selloff in crude oil.
With the short-term situation proving fluid as governments around the world initiate several control measures, there is still a great amount of uncertainty on what the full impact of the virus might be for the oil industry and how things will develop. For instance, many are uncertain as to whether Saudi Arabia will continue with its voluntary cut of 400,000 bpd.
What is certain however is that the oil industry has survived many periods of hardship including the 2008 financial crash and will survive this latest ‘Black Swan’ event.
Many in the industry are confident in their ability to weather market volatility as they had done in previous low-price storms in 2008 and 2016. However, producers and supply chains have had to adapt.
In response to strained demand, some oil producing countries like Saudi Arabia, Iraq and Nigeria have opted to sell crude oil at discounted rates and several oil companies are scaling down on their exploration, production and new projects budget. Oil majors like Royal Dutch Shell and Chevron are taking immediate steps to ensure they are well-positioned for the eventual economic recovery and are significantly reducing their capital spending plan and suspending share repurchases to prioritise long term value and protect dividends.
Goldman Sachs said in a research note published on 30 March, that global oil demand has fallen 25% in the wake of the Coronavirus. They added that “Not only is this the largest economic shock of our lifetimes, but carbon-based industries like oil sit in the cross-hairs as they have historically served as the cornerstone of social interactions and globalization, the prevention of which are the main defence against the virus”.
It is clear now that the crisis has revealed certain truths about international cooperation, governance, and the energy system.
Companies and oil industry bodies are calling for governments across the world to put measures in place to support their respective oil industries. In the United States, there has already been a focus on mobilising stimulus funding to purchase crude oil for the Strategic Petroleum Reserve to help prop up the countries’ gas and oil producers. Likewise, industry trade unions in the UK met with Scotland’s energy minister to discuss future proof plans for the industry’s skilled workers operating in the North Sea. Such initiatives should help protect the industry and safeguard its workers during this period of uncertainty.
The OPEC / non-OPEC agreement to cut production, achieved in mid-April with the support of the USA, sends a positive signal, and marks the end of the Russia /Saudi Arabia price war. Yet with the deal not due to take effect until the beginning of May, stocks continue to build and the market remains oversupplied.
A key question for many analysts and companies affected is whether the size of the cuts agreed will be enough and in time to improve global oil balances to support prices above current levels
In the longer term, many are looking towards the likely resurgence of oil demand in 2021. Once the outbreak is controlled, the global economy, particularly China and India, is expected to rebound at a notable rate. As a result, global oil demand could double or triple to make up for the lost demand.
The oil industry is resilient and well positioned to withstand this challenging environment and weather market volatility. For oil companies, the priority is to put the health and safety of their staff and customers first and ensure the safety of their business operations.
While it is simply too early to tell the energy outlook for the future as a result of the Covid-19 influence, the world will move beyond this and the business case for streamlining operations and investing in resilience planning will be reinforced and widely accepted.
Boris Ivanov is the Founder and Managing Director of GPB Global Resources B.V.