The plunging demand for oil wrought by the coronavirus pandemic combined with a savage price war has left the fossil fuel industry broken and in survival mode, according to analysts. It faces the gravest challenge in its 100-year history, they say, one that will permanently alter the industry. With some calling the scene a “hellscape“, the least lurid description is “unprecedented“.
A key question is whether this will permanently alter the course of the climate crisis. Many experts think it might well do so, pulling forward the date at which demand for oil and gas peaks, never to recover, and allowing the atmosphere to gradually heal.
The boldest say peak fossil fuel demand may have been dragged into the here and now, and that 2019 will go down in history as the peak year for carbon emissions. But some take an opposing view: the fossil fuel industry will bounce back as it always has, and bargain basement oil prices will slow the much-needed transition to green energy.
Who is right depends on a heady mix of geopolitics, profit, investor sentiment, government bailouts and net zero emissions targets, campaigner pressures and, not least, consumer behaviour – is virtual working, for instance, the new normal?
What is beyond doubt is the carnage in the sector. The lowest oil prices for almost two decades, with worse potentially on the way. Some oil major stock market valuations halved since January. At least two-thirds of annual investment – $130bn – dumped and tens of thousands of job losses. In a few markets prices have gone negative – sellers will pay you to take the oil, as global storage capacity fills.
“The price war and Covid-19 have really thrown the oil and gas sector into turmoil, and now we have companies really in survival mode,” said Valentina Kretzschmar, director of corporate research at analysts Wood Mackenzie.
Oil wells responsible for almost 1m barrels a day may have already been shut down because the price of oil is now lower than the cost of shipping it, according to US banking giant Goldman Sachs, with the number of wells growing “by the hour”. This is likely to “permanently alter the energy industry and its geopolitics” and “shift the debate around climate change”, said Jeffrey Currie, head of commodities at the bank.
Demand for oil has plummeted as the coronavirus locks down people in their homes and airplanes on runways. “The virus will bring forward peak demand for fossil fuels,” said Kingsmill Bond, at analysts Carbon Tracker. This latest cyclical oil shock is hitting an industry already heading towards a structural peak created by nations committing to net zero future emissions, he said.
“As for the impact of the virus on the timing [of peak demand], it depends of course on the severity,” he said. In 2018, Carbon Tracker estimated peak demand would come in 2023 but Bond said it was possible that the crisis has advanced this by three years. “That means that peak emissions was almost certainly 2019, and perhaps peak fossil fuels as well,” he said. “It will be touch and go if there can be another mini-peak in 2022, before the inexorable decline begins.”
While the oil companies themselves have long argued peak demand is too far off to put a number on, most observers thought it would happen this decade. Mark Lewis, head of climate change investment research at BNP Paribas, agreed the crises could bring it closer.
“When the dust settles, the peak demand narrative will be there stronger than ever,” he said. “This is particularly true if long-haul aviation fails to recover. This has been a very strong source of oil demand growth in recent years but the longer we are at home – remote working, using video conferencing – the more people will wonder: do we really need to get on a plane?”
End of an era?
The oil price plunge has also demolished the lucrative returns on exploration projects to which investors have become accustomed. This threatens what Lewis calls the “golden dividend era” of the last two decades, which has made oil stocks mainstays of portfolios.
Wood Mackenzie last week analysed the impact of an oil price of $35 on companies’ previous investment plans for 2020. “It’s a very, very ugly picture,” said Kretzschmar. “At $35 per barrel, 75% of projects don’t even cover the cost of capital.”
Most strikingly, the fat rates of return projected for the oil and gas projects have slumped from about 20% down to 6%, she said. “They’re very much in line now with what you can get from solar and wind projects.”
“The oil and gas sector is already a very much unloved sector by investors and in this kind of oil price environment, it becomes low return, high risk and high carbon,” Kretzschmar said. “It is not a very attractive proposition.” With oil prices predicted by some to collapse even further, Kretzschmar is blunt: “At $20 [the industry] will be decimated.”
The oil industry was already under pressure from investors concerned about the climate crisis and increasing regulation from governments to cut emissions. Colin Melvin, at Arkadiko Partners, a consultancy advising some of the world’s biggest investment management and pension funds, said that after the crisis he expects investment to flow increasingly towards companies perceived to offer wider social benefits.
“The purpose of the investment of capital in business is to create wellbeing, to create wealth in the true sense, and I think that is going to become more and more relevant to investors,” he said.
Adam Matthews, director of ethics and engagement at the Church of England pensions board, said the implications for the oil and gas sector could be significant. “[Demand reduction] could be the catalyst for rapid change and I think investors are going to look at long term systemic challenges very closely and want to see much greater resilience.”
As well as climate concerns, the wild instability of the oil markets provoked by the crises may also deter investors, according to analysis from the University of Oxford’s Institute for Energy Studies: “This is a market that is being tested to its limits.”
However, not all experts think the oil industry’s loss is necessarily a gain for green energy and the climate. “If anything it may hold up the share of oil for longer, because it’s cheaper. It could be bad news from a climate point of view,” said Dieter Helm, professor of energy policy at the University of Oxford.
He said securing a green economic recovery from the coronavirus crisis will require deliberate policy measures from governments: “This is where the carbon tax comes in. Now is the moment.”
Governments are deploying stupendous sums to stimulate the coronavirus-wracked global economy – $5 trillion from the G20 nations alone – but how it is disbursed remains uncertain. European Union leaders have promised to make their emergency measures align with their Green Deal programme and Fatih Birol, executive director at the International Energy Agency, has said there is an “historic opportunity” to pour investment into energy technologies that cut greenhouse gas emissions.
But the $2tn US coronavirus relief package is doling out $60bn to struggling airlines and offering low-interest loans that are available to fossil fuel companies, without requiring any action to stem the climate emergency. The Canadian government has said it will give loans to its oil companies, who say they are on “life support“.
After the 2008 global financial crisis, there were high hopes that the trillions of dollars delivered at that time would green the economy, but fossil fuels and their emissions powered on, ever upwards. Bond said: “The big difference to 2008 is that the cost of renewables is now below that of fossil fuels. There is no point trying to sustain the unsustainable high-cost fossil assets in any event. It would be deeply ironic for [neoliberal] advocates of Ayn Rand to ask for a government bailout.”
Adrienne Buller, an economist at the Common Wealth thinktank, said governments in countries like the UK, US and Canada should now consider nationalising major oil corporations.
“Fossil fuel companies won’t be allowed to fail en masse.
Any bailout should at a bare minimum come with equivalent public stakes in the companies, and strong conditions for environmental and climate protections and a transition away from fossil fuel production.
“However, given the intent of acquiring this stake should be to wind down production as rapidly as feasible while ensuring a just transition for workers and security of energy supply, nationalisation may be more appropriate and pragmatic.”
The global industry trade body, the International Association of Oil and Gas Producers, insists its members have a vital role after the pandemic. “Oil and gas play a significant role in the global energy mix and will do so in the future,” said a spokesman. “It is too early to predict what the midterm impact will be. But the oil and gas industry has a history of successfully responding to difficult situations and we anticipate that it will adapt as it has before.”
“Furthermore, the industry has been a key engine of prosperity and a driver of innovation for many decades,” he said. “It has the experience, skills, knowledge and resources needed to realise a low-emissions energy future – a transition that would be more difficult and more expensive without it.”
‘Saudi Arabia is desparate to cash out’
Adding fuel to the fire of the pandemic is the price war being waged by Saudi Arabia and Russia, who increased production just as the pandemic slashed demand, sending prices towards the floor. The moves are seen as an attempt to grab market share by killing the higher cost producers behind the US shale boom.
Prof Bernard Haykel, at Princeton University, US, said it also reflects a more fundamental strategic shift led by Saudi Arabia’s crown prince, Mohammed bin Salman: “With a global clean-energy transition inevitable, he is desperate to cash out while the Kingdom still can.”
The lasting impact of the price war depends on how long Saudi Arabia and Russia can keep pumping cheap oil. While their production costs are very low, they depend on high revenues to balance their national budgets.
Michael Liebreich, at Bloomberg New Energy Finance, said the fiscal break-even for Saudi Arabia is around $80 per barrel, meaning its foreign exchange reserves might sustain rock-bottom oil prices for only two or three years. “Russia, with a $40 a barrel fiscal break-even and much more diversified economy, can survive low oil prices for a decade,” he said.
Whatever happens, the industry will never be the same again after the double whammy of the pandemic and price war. “The companies that emerge from the crisis will not be the ones that went into it,” said Carbon Tracker’s Bond. “We will see write-downs, restructuring and radical change.”
Experts, including Currie at Goldman Sachs, say the climate change debate will almost certainly take a difference course after the crisis. But exactly what that looks like remains to be seen. “The question is how long this is all going to last, and no one really knows,” said Kretzschmar.