Editorial: Supply -- but no demand
The last century’s two global conflicts excepted, the world’s economic underpinnings have never seemed quite so shaky. Those wars also brought profound political and social changes; today, seismic shifts are also in the cards.
Even before the recent pandemic slashed oil demand there were signs of a worldwide recession. These have now become much clearer. The obvious indicators, energy prices, were in free-fall until politicians appeared to act in concert. Hints of a US-led political solution emerged April 2 as dated Brent crude jumped 20% in a few hours of news of the president Donald Trump’s phone-call to Riyadh.
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The recession was particularly evident in the LNG segment: a combination of sluggish Asian demand, mild winters in the northern hemisphere, plenty of European storage and new production starting up in Australia, Russia and the US sent spot prices down much more sharply as Covid-19 bit.
Electricity demand has also plunged with the lockdowns, meaning that those oil companies with wind and solar projects may delay taking final investment decisions and commissioning.
The crash therefore raises doubts over the credibility of the international oil companies’ earlier plans to pursue ambitious targets for scaling back their carbon emissions.
A trendsetter was Spain’s Repsol, which in December said it would bring carbon emissions from operations and most of its products to zero by 2050. The move won praise from climate-conscious investors, even though Repsol conceded that it would have to rely on technology not yet developed to implement a large share of the cuts.
Even so, other oil companies took notice of the positive reception that Repsol received and they followed suit. These included Norway’s Equinor, Italy’s Eni and BP.
Their US counterparts Chevron, ConocoPhillips and ExxonMobil did not jump on the bandwagon. ExxonMobil CEO Darren Woods recently described such climate pledges as “a beauty competition” that did little to address the emissions issue in practical terms. Dirty assets were merely sold to less green operators, and perhaps at a sizeable discount, destroying shareholder value. ExxonMobil is still committed to the problem, he said, but is approaching it from a global perspective.
Those that did announce sweeping carbon reduction strategies have now had to slash their capital expenditure for 2020 by 20-30%, cut dividends and share buy-backs and also issue bonds to weather the storm. Many have cancelled all discretionary spending, which includes investments in decarbonisation.
“In a $60/b oil price environment, most companies were generating strong cash flow and could afford to think about carbon mitigation strategies. But now, the sector will struggle to generate enough cash to maintain operations and honour shareholder commitments,” Valentina Kretzschmar of Wood Mackenzie says. Those companies that haven’t taken decarbonisation steps already are now unlikely to do so unless they are blessed with strong balance sheets – and there are precious few of those left as the industry moves into survival mode.
The threat that cheap oil poses to the energy transition was also recently flagged up by the International Energy Agency (IEA)’s head Fatih Birol.
“The combination of the coronavirus and volatile market conditions will distract the attention of policy-makers, business leaders and investors away from clean energy transitions,” he warned in late March. “Observers will quickly notice if their emphasis on clean energy transitions fades when market conditions become more challenging.”
Norway’s Rystad Energy estimates that the growth rate in renewable energy projects being commissioned will be flat this year as a result of the pandemic. Earlier it had predicted a year-on-year rise of 15% for solar and 6% for wind respectively.
Meanwhile, pressure from investors, regulators and environmentalists on oil companies to lower their carbon emissions is unlikely to abate. Fortuitously many financial institutions sold their fossil fuel stocks before the crash; but the question now is, who will underwrite these trillions of dollars of investments: taxpayers, or private investors – subsidised by taxpayers?
The path that the oil and gas industry takes will depend greatly on the price when the dust settles. Even after the pandemic has subsided, its economic ramifications – heavy debt burdens -- will be felt for years.
One of the greatest uncertainties is how the oil supply showdown between Russia and Saudi Arabia will play out. Oil prices spiked on April 2, after US president Donald Trump said he expected the two countries to take 10mn barrels of supply offline.
Without a recovery in oil prices, hundreds of US shale producers could go under. The oil price crash claimed its first casualty at the start of this month: Whiting Petroleum. If and when prices do rise, US shale producers will get back into business, capping prices once more.
It is implausible that Russia and Saudi Arabia would commit to such a reduction alone, while US producers are individual companies governed by competition law, although the Texas Railroad Commission is considering imposing quotas, and Alberta’s premier Jason Kenney has expressed a willingness to join in global production cuts. But traders nevertheless were encouraged by signs that the world’s two biggest producers after the US were having second thoughts about launching their ill-timed supply war. At time of press, an Opec meeting was planned with Russia’s participation uncertain.
But the big producers’ strategy of flooding the market could backfire, even if the aim is to wipe out the competition. After all, Riyadh employed the same tactics in 2014 and succeeded only in wreaking havoc on its finances and making the US competition more efficient. And the Russian rouble has also fallen sharply. This time the consequences could also have repercussions at home. Autocracies are fundamentally brittle.