INSIGHTS FROM AMPHORA

Part 1 - Climate Change, Covid-19 & Oil Prices

Balancing the need for continued revenues in the face of climate change

There is an unwritten rule about starting an article with a graph. However, an exception must be made for this graph, produced by the International Energy Agency, written in the final part of 2019.

It marks out one of the most important predictors of the near and mid-term of the oil and gas industry. This graph perfectly captures why we just saw the collapse of Brent from $53 to $21 in just five weeks. Covid 19 was just the catalyst to a much-anticipated response by big oil producers, who are both capable and willing to address their long-term existential threat brought on by climate change to their primary revenue generator.

To briefly describe the graph, the IEA outlines three possible alternative scenarios that map oil prices to the deepening climate change threat:

Figure 1 : ‘Oil and Gas Industry in energy transitions’ IEA.org Jan 2020

  1. Stated Policies Scenario. A classical model balancing the upward drift of oil price in light of requirements for new source development. This effectively ignores any downward pressure placed on oil from environmental angles.
  2. The Sustainable Development Scenario. A rising demand is largely met by sustainable alternatives to oil as set out by the targets of the Paris Climate Accord in 2015. Thereby oil prices gradually decline in line with replacement energy, which favours more efficient producers or those with a much lower cost of production.
  3. The red line is the aptly called Disjointed Transition Phase where large resource holders grow their production and force out higher cost producers.

To quote from the IEA paper ‘…faced with rapidly falling demand, major resource holders could choose an alternative strategy and look to ramp up production in an attempt to gain market share while there is still scope to do so. In this event, the combination of falling demand and increased availability of low-cost oil would undoubtedly lead to even lower prices. This situation is modelled here in the Low Oil Price – SDS Case (LOP-SDS). In the early 2020s, large resource holders rapidly increased production by fully utilising all of their spare production capacity: this leads to an overhang of supply and a sudden drop in the oil price.’

As a result, scenario number 3 has come into play much sooner than we could have predicted (at the time of writing demand has fallen to levels last seen in 1995). A better name for it would be ‘the gloves are off’ scenario. Welcome to a decade of sky-high volatility coupled with generally lower oil prices.

When Amphora commissioned interviews of the Oil community in Q4 2019, we had an inkling that events weren’t going to remain balanced supply/demand for long. The world was awash with cheap energy before the crisis, and balancing energy supply at $50+ /bbl was not altogether realistic. The near/mid term would be different to the one painted by primary Western news feeds where most attention is focused on ‘transition’ and ‘climate emergency.’ To that end, Western Oil Majors have adopted the messaging as their own and present the transition to a low carbon economy as something achievable within a time frame of just over ten years.

Many of the respondents from the oil community were bullish about oil’s mid-term future. In fact, many were tacitly admitting that oil prices would see a downward jolt. This is somewhat opposite to the perception of a Western press reading audience.

This article, a second in the series, explores what we learned from our market study. It places their stated responses in context with today’s economic impact and relevant market data.

A brief introduction to our study:

We approached 2500 executives who are suppliers, traders and financiers of the oil and gas industry. Interviews were held with respondents who were willing/able to provide their insight.

Respondents from 5 continents, 150+ companies.

Our target study group:

We deliberately avoided conversations with oil majors but instead focused our time on National Oil Companies (NOCs), Internationally active oil companies (INOCs) and independent trading houses (independents).

We did this for three reasons:

  1. It represents our customer base
  2. Because when the industry is taken as a whole, oil majors tend to have an outsized influence given their hold just over 10% of the reserves
  3. They include the major low-cost resource holders. Our dialogue for the future must include the companies

Figure 2. Oil Majors hold only 10% of the global reserves, and are responsible for just 12% of the oil/gas production today. Why are their voices so prominent?

The survey was qualitative in nature and aimed at capturing the sentiment of companies not normally given a voice by Western Press. A sample of our questions are found below:

The energy landscape as we know is poised for foundational change between now and 2050. What does this mean for your company and the leadership team?

How did you balance affordable, reliable supplies of liquids and gases with the need to meet the Paris Agreement?

Can you balance operational profitability with an increasingly volatile landscape?

Do you believe that sources of finance for both trade and capital investment will become tighter in the next decade?

The word cloud in the Figure below represents the weighting of our respondents. Here are just some of the highlights of their opinions expressed in interviews:

100% of respondents acknowledged that there is a need to tackle climate change, but very few would provide an example of their own company’s effort to reduce carbon intensity

Less than 50% cited the US abundance of oil as their second biggest challenge

Over 20% said that oil is perceived with the same negative connotations in their own sphere of operations as it is in the West. A favourite phrase was ‘oil is here for longer than we think.’

Less than 80% of companies believe that funding is available for new ventures – particularly in Africa. Anecdotally we heard several examples of high risk, high reward strategies delivering oil products to numerous East African countries.

The survey highlighted strong underlying themes: for the majority of the NOCs and INOCs they have a duty of care to their shareholder – a national government. Somehow technology would be a great leveller and a future saviour. For the moment US oil imports at just 3mb/day was a greater concern.

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