Will Covid-19 hasten the death of the oil industry?

Square

Within the past decade, the petroleum sectors’ problems have finally been revealed to the general public, most notably its environmental impact and its contribution to climate change. Combined with the rising demand for alternative renewable energy sources, such as wind and solar power, the long-term decline of the oil industry is inevitable. However, the coronavirus pandemic seems to have accelerated this decline and turned it into a free-fall that the oil industry might never be able to recover from.

The Coronavirus Crisis

In recent times, the oil industry has encountered multiple crises, where oil prices have crashed due to falls in demand , first after the credit crunch, then the 2016 plunge in prices because of a supply glut but it has managed to recover each time, albeit with some price volatility. Yet the current pandemic has caused the largest crash in oil prices in its 100 year history.

Due to the coronavirus pandemic:

  • Air traffic has fallen ( by 63% from 2019) due to travel restrictions, significantly reducing global demand for oil as less aviation fuel is being used
  • Speculators with oil futures had little confidence that the falling oil prices would recover, so they sold their contracts in the economic downturn, causing further drops in the price of futures contracts
  • There has been an oil price war over market share between Saudi Arabia and Russia, from March to early May, leading to rising geopolitical tensions
  • As a result of this, the oil and gas sector has lost 45% of its total value from January to April 2020

The consequences were so great that by late April, US producers with futures realised they would be unable to store more unsold barrels of oil and they would pay above market price to do so. They began paying buyers to take these leftover stocks, causing a fall into negative prices (US benchmark West Texas Intermediate fell to $-38).

In previous oil crises, low oil prices have lowered costs of production for refineries, which passed onto consumers with lower petroleum prices; this helped to increase consumer demand once again. However, due to Covid-19, around 760 million people have remained at home, and transportation has not been used. Since transportation consumes nearly 70% of petroleum products, demand for crude oil used in petroleum production will remain low until measures to combat coronavirus are relaxed.

Also, with storage facilities reaching full capacity by July, oil producers have been forced to halt production, with reductions from 20-35%, known in the industry as ‘shutting in’. Jeffery Currie, global head of commodities as Goldman Sachs, anticipates “a very quick risk reversal towards oil shortages”, leading to “an inflationary oil supply shock of historic proportions.”

Such price volatility from all-time low to historical highs is not likely to instil the crude traders with confidence. As a result, investment is being withdrawn both due to the immediate crisis at hand, and the long-term decline of the oil industry as the world switches to renewable energy. Oil producers now face rising costs of capital for operations, adding to the list of serious issues. This March, asset owners with over $12 trillion in AUM have pledged to divert funding away from fossil fuels, and the world’s largest fund house, BlackRock, added climate analysis as a consideration when choosing investments. Potential investors in the oil industry not only face climate-related backlash and loss of the public’s support, but now the oil industry has become unprofitable and unnecessarily risky.

Experts also recognise that the coronavirus situation has forced many more people to work from home, and this could become a deep-rooted habit long after the crisis, where technology is used for working remotely with people rather than commuting on cars or planes to meet them physically. This has already been seen with Facebook allowing all of its employees working from until the end of 2025. Firms may also favour remote conferences to travelling because any booked flights may be cancelled in the wake of a potential second peak of the virus. This would further reduce demand for air travel, and it therefore promises a knock-on effect onto oil demand.

The Role of Government Intervention

By late April, the aforementioned oil price war between Russia and Saudi Arabia was at last halted. Major oil producing countries, including the U.S.A, signed the OPEC+ agreement, pledging to reduce oil production by 9.7 million barrels per day in an attempt to artificially recover oil prices; it was the largest oil output cut in history.

This will save hundreds of thousands of energy jobs in the United States

Donald Trump, US president
Price of West Texas Intermediate crude oil (WTI) over the 6 months

It is estimated that Russia’s break even price is around $42, and Saudi Arabia needs the $83 handle to do the same, yet the benchmark West Texas Intermediate still trades at $39. This means that the world’s major oil producers are still operating at a loss, despite signing a seemingly revolutionary new deal. Oil firms cannot sustain heavy losses for much longer; the risk of eventual bankruptcy is ominous.

Despite the failed attempts to support the industry, and the knowledge that renewable energy is just around the corner, certain short-sighted and stubborn governments continue to provide bailout packages to major oil providers. At least 90 fossil fuel companies, including industry giants ExxonMobil and Chevron, will see their bonds bought back by the U.S government. This bond buyback scheme is set to be worth at least $750 billion even though the oil industry is broken beyond repair.

In the face of the coronavirus pandemic, the world now has the opportunity to transition to a greener society. This was always environmentally and socially favourable – now it seems for governments this is economically feasible as well. At last, equity returns for oil are below 10% and offshore wind power is higher and rising at 11%, making oil an unfavourable choice for investors and governments. By putting the climate agenda at the centre of the stimulus packages, jobs lost from the oil industry, with training and support, could be redistributed to the renewable sector, thus restarting economies and reining in unemployment rates.

An unintended symptom of coronavirus will accelerate the demise of the oil industry. We now must use this as a chance to propel the world to a green, economically sustainable future.


References

  1. Jillian Ambrose, The Guardian (2020), “Oil prices dip below zero as producers forced to pay to dispose of excess” https://www.theguardian.com/world/2020/apr/20/oil-prices-sink-to-20-year-low-as-un-sounds-alarm-on-to-covid-19-relief-fund
  2. Centre for Environmental Law (2020) “Pandemic Crisis, Systemic Decline” https://www.ciel.org/wp-content/uploads/2020/04/Pandemic-Crisis-Systemic-Decline-April-2020.pdf
  3. International Energy Agency (2020) “The global oil industry is experiencing a shock like no other in its history” https://www.iea.org/articles/the-global-oil-industry-is-experiencing-shock-like-no-other-in-its-history
  4. Ben Chapman, The Independent (2020), “Could the coronavirus crisis be the beginning of the end for the oil industry?” https://www.independent.co.uk/news/business/analysis-and-features/coronavirus-oil-gas-industry-climate-change-renewable-energy-a9453756.html
  5. CNBC (2020) “OPEC and allies finalize record oil production cut after days of discussion” https://www.cnbc.com/2020/04/12/opec-and-allies-finalize-record-oil-production-cut-after-days-of-discussion.html
  6. https://markets.businessinsider.com/commodities/oil-price?type=wti
  7. Wal van Lierop, Forbes (2020) “After COVID-19, The Oil Industry Will Not Return To ‘Normal’ ” https://www.forbes.com/sites/walvanlierop/2020/04/05/after-covid-19-the-oil-industry-will-not-return-to-normal/#63671322281e
  8. Fiona Harvey, The Guardian (2020) “US fossil fuel giants set for a coronavirus bailout bonanza” https://www.theguardian.com/environment/2020/may/12/us-fossil-fuel-companies-coronavirus-bailout-oil-coal-fracking-giants-bond-scheme
  9. Graph credit: FT

Author

Leave a Comment