By Juan Alario, a former EIB Associate Director. He is a member of the GCPF Investment Committee and a Senior Financial Advisor of GNE Finance
In March/April 2020, global oil consumption experienced a 25-30% sudden and unprecedented drop, in a market with excess supply. Oil companies had to resort to storing a lot of their oil production, because of the impossibility to adjust the supply in such a short time. Spot prices drop temporarily into negative territory for the first time in history1. The coronavirus pandemic marks the start of a new oil crisis and a major transformation of the world oil market.
“Covid-19 crisis is only ‘adding to the challenges of oil in the years ahead’” BP’s new chief executive said in a recent interview2.
Short term developments
Short term demand developments depends on the duration of the pandemic and its economic impact (V, U or L shaped), but nobody has a clue right now. The most common scenarios predict that the world will reach the previous level of GDP and of oil consumption by early 2021 or in 2026.
Production from existing oil fields can be gradually reduced without damaging them. If the decrease is too fast, some of the existing fields will suffer a permanent decrease in production capacity and others will have to be abandoned. Investment in existing or new fields is being significantly reduced (30%, 20% and 24% reductions announced by Exxon, BP or Aramco respectively3). On the other hand, investment will decline much quicker in oil shale (duration of a well of about 2 years) than in on-shore of off-shore fields.
Prices4 should gradually increase, as existing over-capacity is absorbed. Contracts for Brent oil in December 2026 are currently trading at about 50 USD/bbl. Therefore, the market does not expect that prices will reach the pre-crisis level of December 2019 (about 69 USD/b).
Long term developments
Most of the oil demand increase is expected in emerging economies of Asia, followed at distance by other emerging and developing economies. There is extreme uncertainty at this stage. Recent economic forecasts (IMF April 2020) are more pessimistic than before. It is likely that the pandemic has long lasting impacts on the long term economic growth of emerging economies. Air transport will also struggle to recover from this crisis. Apart from economic growth, long term factors with a significant impact on oil demand are the same as before the pandemic: improvements in energy efficiency in transport (road, maritime and air), electrification of transport and penetration of fuels other than oil (natural gas and biofuels).
Existing oil demand scenarios, which are mainly driven by supply-demand, climate change and other environmental policies (e.g. plastic), are outdated. New scenarios must take the impact of the pandemic into account. Oil consumption for transport (about 58% of oil consumption today) may decrease depending on whether a significant part of certain activities will move on-line (office work, education, health, justice, etc.), changes in the supply chains (de-globalization) and tourism. The demand of oil used for the production of petrochemicals (17% of the total) may also decreases, depending on policies to reduce or recycle plastics. Given these trends, we may reach an oil demand peak earlier than expected (projected for 2030-40); in fact, we may have already reached the peak! However, there are considerable uncertainties on demand developments, including on the impact of low oil prices on demand.
The myth of the inevitable scarcity of oil is over5. The future of oil supply will be characterized by oil abundance. But in the unlikely event that we reach an oil production peak, it will certainly be after an oil demand peak. Fortunately, we can now hope that a lot of oil will be left in the ground. The oil based phase of humanity’s development path may wane sooner than initially expected, and interestingly it will follow the steps taken by coal before.
The OPEC market share has been declining, starting with the first oil shock of 1973 (from 57% to 41%6 in 2018). Still OPEC, reinforced with Russia and others, the so-called OPEC+, can significantly influence price developments. However, OPEC+ policies of keeping oil prices high have become increasingly unsustainable. Cost of non-OPEC oil has decreased, both for oil shale in the US (average of 32-38 USD/b in 20167, most likely lower today) or for off-shore oil (mostly at less than 50 USD/b8). OPEC+ will be forced to change the focus of their policy to volume rather than on price9, but this change will be gradual, in order to have time to adjust their economies to a less oil dependent economy. OPEC+ bear lower prices, as they have the lowest cost of production (often less than 20 USD/b10 in the Middle East).
Geopolitical considerations will continue to play a critical and uncertain role in price developments, notably political instability in the Middle East. Key players in the oil market are Saudi Arabia, US and Russia.
To sum up, in the short term, oil price should gradually increase in the next few years, in line with the economic recovery. In the long run, the focus of this article, there will be two conflicting trends:
- COVID-19 could significantly reduce oil demand, particularly because of lower transport needs.
- Moderate or low oil prices, due to abundant oil supply, will favour oil demand increases through price elasticity.
It is quite likely that oil demand has peaked. It will depend on the impact of the pandemic on economic growth, notably in emerging economies and on climate change policies (improvements in energy efficiency in transport and expansion of electricity and biofuels in transport).
Oil prices should increase as the economies recover from the pandemic. Over the long term, oil prices will remain very volatile, but my expectation is that, in average, prices are at a moderate level and tending to decline.
All views are strictly personal.
1 On recent developments see: The Oxford Energy Studies, The new deal for energy markets April 2020 and The Oxford Energy Studies, Oil Benchmarks under stress April 2020
2 FT May 12, 2020
3 From the Financial Times
4 Oil prices have been very volatile since the first oil crisis in 1973. Brent spot price FOB have varied from 11 to 140 USD/bbl in 1987- end 2019 in nominal terms.
5 Peter R. Odell, Global and regional energy supplies: recent fictions and fallacies revisited. Energy Policy April 1992
6 IEA, Oil Market report 2 March 2020
7 D.Babusiaux and others, Un point sur les pétroles de gisements compacts Revue de l’energie December 2017
8 Denis Babusiaux and others, Le point sur la production des pétroles en mer, Revue de l’Energie Sep-October 2019
9 The Oxford Energy Studies, Peak oil demand and long run oil prices January 2018
10 Denis Babusiaux and others (2019)