INSIGHTS FROM AMPHORA

Will the current health crisis hasten

the early peak of oil demand?

An interview with Matthew Parry of Energy Aspects

The sharp drop in demand for oil and the resulting price crash made headlines across the globe. Many pundits seized on this as a Black Swan event that will drive the transition to renewables and bring forward peak oil use. Before the coronavirus crisis, there was broad agreement that oil use would peak in 2035. Now there is talk of that happening a whole decade earlier, in 2025. Following the publication of the IEA’s ‘Global Energy Review 2020’, Matthew Parry, head of long term forecasting with Energy Aspects, an independent research consultancy specialising in global energy markets, shares his insights on the future of oil and maintaining hydrocarbon revenues with Amphora’s Ivan O’Toole.

At the same time, shareholders have been pushing companies to respond to environmental issues. The likes of Shell, BP and Repsol are all talking about various commitments to carbon neutrality. But the problem is that these initiatives are entirely funded by income from fossil fuels. So, as the price of oil is coming down, oil companies’ commitments to carbon targets may well mean that they invest less in oil. Then, as a result of not benefiting from oil price gains, these companies will have less money available to invest. If and when the oil price rises, some companies with less of a focus on environmental concerns, are going to see a better return because they are investing in oil.

Government Intervention

This turn of events has lent weight to the argument for government intervention. George Monbiot wrote in The Guardian: “Do Not Resuscitate. This tag should be attached to the oil, airline and car industries. Governments should provide financial support to company workers while refashioning the economy to provide new jobs in different sectors. They should prop up only those sectors that will help secure the survival of humanity and the rest of the living world. They should either buy up the dirty industries and turn them towards clean technologies or do what they often call for but never really want: let the market decide. In other words, allow these companies to fail.”

The issue, of course, is that governments worldwide have spent unprecedented sums on shoring up their economy. They are likely to argue that there is little budget left for the investment needed for capital investment in greener energy infrastructure, whether that is supporting electric vehicles or powering homes and businesses.

North American is a case in point. Shale oil has seen a massive impact from declining demand and energy investment is down 25% in the US. The future of the US as an oil exporter looks in doubt for the next three to five years, following years of bountiful cashflow and solid returns. US oil supply was highly responsive to demand and provided good returns in boom times. The downturn has shone a spotlight on the fact that the US was among the most expensive producers. When the price was over $100 a barrel, that didn’t matter hugely. Now, much lower prices mean that production is in danger of becoming unprofitable.

The US government has suggested it may support ailing oil companies, to the dismay of free-market proponents and to the increasing jeopardy of Paris Climate Change Agreement. But the oil market is a good example of the failure of the free market to work as expected. There is too little investment when prices are low and too much when the price is high. Lead times in the industry demand investment with at least a two-year horizon. So, when the US government says it is going to support the market, it is a good idea.

Do Not Resuscitate. This tag should be attached to the oil, airline and car industries. Governments should provide financial support to company workers while refashioning the economy to provide new jobs in different sectors. They should prop up only those sectors that will help secure the survival of humanity and the rest of the living world. They should either buy up the dirty industries and turn them towards clean technologies, or do what they often call for but never really want: let the market decide. In other words, allow these companies to fail

Muddling through in the midstream

Much of the focus on maintaining revenues in the oil and gas sector focuses on the likely impact of consumer choice and government policy affecting upstream exploration and production. Midstream, where the refineries sit, faces an even more complex financing challenge.

A number of factors will affect the financing of refineries as the industry recovers from the current health crisis. Issues of supply and demand and long lead times are ongoing for refineries, exacerbated by changing demands for fuels at the lighter end of the barrel. In the past, refineries have weathered downward price pressure, as they still made a margin.

Now, more refiners are able to make ultra-low sulphur fuel oil as well as some of the heavier products. The future needs to be more focused on the lighter end of the barrel, but this needs more investment. In india, refineries have been created in anticipation of demand, and these new refineries will be very much more competitive than European refineries. It is looking increasingly less sensible to shore up legacy European refineries.

Crystal ball gazing - near term predictions

Forecasts are hard to make with confidence when the familiar economic cycle has been replaced by a much more nebulous epidemiological cycle. The IEA predicts: “The energy sector that emerges from the Covid‑19 crisis may look significantly different from what came before. Low prices and low demand in all sub-sectors will leave energy companies with weakened financial positions and often strained balance sheets. Business lines that are insulated to a degree from market signals, including those with renewable electricity projects, will emerge in the best financial position. Private firms that are the most exposed to market prices will experience the most severe financial impacts. Market concentration and consolidations are likely.

Right now, we're seeing demand fall by something between six to seven million barrels for the year as a whole, which is a huge hit. But a lot of that is temporary – people cancelling their holidays and not driving to work. More normality looks likely by the fourth quarter and then through 2021.

The energy sector that emerges from the Covid‑19 crisis may look significantly different from what came before. Low prices and low demand in all sub-sectors will leave energy companies with weakened financial positions and often strained balance sheets. Business lines that are insulated to a degree from market signals, including those with renewable electricity projects, will emerge in the best financial position. Private firms that are the most exposed to market prices will experience the most severe financial impacts. Market concentration and consolidations are likely.

Looking to the long term

In 2021, it looks likely that demand will be up, but supply will lag behind because of the lack of investment this year, driving up prices next year. In 2022, we predict above-average growth as confidence returns and the growing number of people with middle-class incomes drives oil consumption in India and China. Shale and tar sands will come back into vogue as demand drives supply again.

It will become increasingly vital for hydrocarbons players to have a clear, end-to-end view of their supply chain to support access to the trade finance needed to survive and thrive beyond the current global health crisis. Amphora’s eBook ‘Agenda 2030: driving continued revenues in global hydrocarbons’ offers oil industry insight and practical recommendations for oil and gas companies looking for the best strategies to maintain revenues

About Matthew Parry

Matthew Parry leads on long-term analysis at Energy Aspects, specialising in oil and macroeconomics. Before joining Energy Aspects, Matthew was responsible for the International Energy Agency’s demand analysis. Here is the link to the homepage.

Energy Aspects is an independent research consultancy specialising in global energy markets. Its experienced analysts have an industry-wide reputation for producing relevant, insightful and timely commentary, analysing market fundamentals and forecasting price movements.

Energy Aspects has just released (late-June) two comprehensive medium-term reports, looking out to 2025, dealing with how energy markets deal with the coronavirus pandemic: it’s Medium-term Oil Market Report and Medium-term LNG.

Reference

1 https://www.iea.org/reports/global-energy-review-2020

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