We all are concerned about the Covid-19 pandemic as well as the resultant economic crisis. The oil market crash of 2020 is a visible indication of this crisis. When will this end? This question is on everyone’s mind, but ‘when’ is also related to ‘how’. Here we examine some fundamental factors, trends, and scenarios.
Read the first part of this story: Oil Crisis 2020 – Oil Glut and Price Wars in the Great Lockdown Economy
© Rasoul Sorkhabi
2020 has not been kind to the petroleum industry. In April this year oil prices fell to their lowest levels in decades. In July, the prices increased to around $40s a barrel, mainly because of oil production cuts of 9.7 MMbopd by OPEC Plus in May to July, and some increase in oil consumption. Nevertheless, lockdowns and restrictions on transportation and travels remain in place in most parts of the world, so oil demand is still well below normal. For the period August-December 2020, OPEC Plus has agreed to cut its production by 7.7 MMbopd. If this holds and if the lockdowns continue as before, oil prices will probably stay in the $40s for the rest of 2020.
Oil prices for Brent crude (Europe) and West Texas Intermediate (USA) in the first and second quarters of 2020. On 20 April 2020, prices dropped below zero for the first time. Source: Rasoul Sorkhabi based on prices posted on Business Markets Insider.
Great Un-Expectations
However, two unexpected factors may actually increase oil prices even during the pandemic. No one, of course, wishes these to happen, but they are not impossible. The first is a serious war in the Middle East or another oil producing region that would seriously disrupt the flow of oil to markets; and the second would be the spread of COVID-19 to oil fields, companies and operations. In 1918 the Spanish Flu materially affected the oil industry. Jeff Spencer of the Petroleum History Institute has discovered several newspaper items documenting the 1918 crisis (New Orleans Geological Society Log, May 2020). For instance, the El Paso Herald dated 21 October 1918, published the following: “Eastland, Texas: Both development and trading during the past week were exceptionally slow in the central Texas oil fields owing largely to so much sickness from influenza. Many of the speculators and buyers have been called home by sickness at home, and more than two-thirds of the rigs have temporarily suspended drilling.” The Casper Star-Tribune dated 18 November 1919, wrote: “Salt Creek is in the throes of an epidemic of Spanish Influenza, there being about 170 cases in that village to date. With no regular doctor there it is doubly hard for those suffering with the disease as well as the Casper doctors who make the trip to Salt Creek every day or two. The weekend brought three deaths from influenza at Salt Creek with many who desperately ill.”
Emergency hospital during the 1918 influenza epidemic, Camp Funston, Kansas. The Spanish flu seriously affected the US oil industry. Original image from National Museum of Health and Medicine. Source: rawpixel.
Oil Price Recovery: Five Scenarios
For oil prices to rise to the pre-pandemic levels, two things will need to happen: the oil glut drains away; and economic activities and transportation are restored as lockdowns are lifted. But what will be the shape of oil market? When will oil prices return to normalcy?
Let’s take $65 a barrel, the price of oil in January 2020, as the normalcy and follow five scenarios for post-lockdown times. We will name these as V, U, W, √, and L.
The V scenario forecasts that just as oil prices crashed very quickly within just two months in early 2020, they will also bounce back as soon as the pandemic and lockdowns are over, and especially if oil production cuts by OPEC Plus continue.
The U scenario – the prolonged recovery – assumes that the pandemic and its economic impact will take a long time (probably a couple of years).
The W scenario – the volatile cycles of ups and downs – assumes that the pandemic-economy nexus will fluctuate and that OPEC Plus will reinstate its on-and-off price wars, at the time of its choosing.
The square root (√) scenario forecasts a major jump in oil prices for a limited period, because of accelerated pace of economic growth on one hand and limited oil supplies on the other hand, as a result of the oil industry’s downsizing during the pandemic.
The L scenario is based on the thinking that once oil prices rise to about $50, renewable energy technologies will be commercially feasible, competitive, and even more attractive because of environmental concerns, political will, and grassroots support to reduce the world’s dependency on the volatile oil. The L scenario will also be heightened if oil producers maintain considerable spare production capacity for years. In these cases, oil may enjoy a short-lived price comeback, but will never see its good old days again.
Texas Railroad Commission
On April 14 this year, the Texas Railroad Commission (TRC) in Austin had an important meeting with representatives from oil companies and trade groups to discuss of the idea of apportioning or limiting oil production because of oil market crash and reduced oil demand. The TRC used to perform this task during the 1930-60s but has not done so for nearly half a century. On May 5, the TRC voted 2-1 against production cuts but voted unanimously in favour of waiving fees for new crude oil storage projects. For the American oil industry this means no official production cuts or quotas – let market forces work, but production is encouraged if companies also build extra storage for crude oil. For OPEC Plus this means: no thank you, we are not joining your club.
It thus seems that the US oil companies, which are heavily involved in shale oil, will have to learn how to live in a volatile business for a long time with capabilities to shut-in and re-open oil wells as needed, and improve the petroleum geoscience and drilling and completion technologies to lower the cost of production (i.e. lower the breakeven price points).
Futures Speculation
In his book Understanding Oil Prices (2012), economist Salvatore Carollo has critiqued the dichotomy between ‘physical oil’ handled by the oil industry, and ‘paper oil’ traded numerous times by market speculators, and how the discrepancies between these two affect the world economy. We witnessed a clear exposé of this dichotomy on April 20 in New York when futures prices of West Texas Intermediate for the month of May dropped to minus $37 a barrel – something unprecedented in the history of oil. The oil sellers actually paid $37 a barrel to buyers to take their oil. Why? Because these sellers were largely hedgers and speculators who had bought oil but did not have the intention or means of keeping it, so they sold it at negative prices a day before the deadline to avoid the actual process of handling and storing crude oil. Oklahoma’s Cushing, the delivery route for WTI, already had full inventories and no spare storage capacity.
The negative price crash only happened to WTI in the New York exchange market but not to the Brent or OPEC Baskest in Europe or Asia, even though WTI is a lighter and better crude than those, because these crudes could be shipped from numerous points worldwide. The negative oil prices for WTI were not really the collapse of the oil industry but a reflection of intricacies in oil trade and markets. Of course, if one group loses money, another group makes money. A lucky example in this case was BB Energy, a London-based oil trading company, which bought 250,000 barrels of oil in the US when the prices turned negative on April 20 because the company had storage capacity for oil.
How this incident will affect the behaviour of oil market speculators in the future will be interesting to watch.
Bankruptcies and Mergers
Crushing oil prices in 2020 have devastated the finances of oil and gas companies around the world. Major companies with huge financial and petroleum assets can withstand such financial crises as they have done in the past. But small to mid-sized, independent companies with huge debts may not survive especially if oil prices remain low for a longer period. Already this year, more than 400 companies in the upstream, midstream and oilfield service sectors have filed for bankruptcy in the US. While most of these were small private companies, several were good-sized and notable names: California Resources, Chesapeake Energy, Diamond Offshore Drilling, Extraction Oil & Gas, Whiting Petroleum, and Ultra Petroleum, for example. Filing for Chapter 11 bankruptcy in the US does not mean the end of the game. Companies usually file for it in order to restructure and protect themselves against debts and creditors; for instance, McDermott International, which had filed for bankruptcy in January, was released from it in June this year. Nevertheless, the high number of these bankruptcies indicate the gravity of financial situation in the oil and gas industry.
Financial consolidation will require mergers and takeovers in the oil industry, as happened in 2000. In July, Chevron purchased Noble Energy for about $5 billion in shares. This takeover was the industry’s first major business deal in the Covid-19 world since Occidental Petroleum outbid Chevron to buy Anadarko for $37 billion in 2019.
An oil rig silhouetted at sunset in the Oklahoma Panhandle. © Gina Dittmer.
The Atlantic Divide
An important trend is that oil companies in North America and Europe seem to be pursuing different strategies. The US companies are still focused on oil and gas exploration and production, while European companies like BP, Eni and Equinor portray themselves as energy companies beyond oil and are planning to drastically cut their carbon footprints and invest in new energy solutions in the coming decades.
The reasons for US petroleum companies to stay in the traditional oil and gas business are obvious. Firstly, this is their comfort zone and it is a field they are good at. Secondly, the shale oil revolution of the recent decade has brought about a prospect of energy independence for the US – a country which consumes 25% of world oil and will need huge energy resources in the coming decades as well. And thirdly, the US under President Trump has left the Paris Agreement on Climate Change and therefore does not see any official commitment to reduce its carbon dioxide emissions (although this policy may change once a new administration comes to power in the White House).
Europe is on a different path. For example, in February this year, Eni announced its strategic plan to 2050, highlighting its mission to cut back on oil production, increase production of natural gas, and reduce its carbon emission by 80%. Also in February this year, BP also announced its desire to eliminate or offset all carbon emissions from its operations as well as the petroleum it sells to customers by 2050.
It is not clear how the European petroleum companies will actually achieve a zero-carbon footprint even if they switch entirely to natural gas (which is still a greenhouse gas). Moreover, it is too soon to evaluate these mission statements: 2050 is three decades from now, and things may take new turns between now and then. Nonetheless, these stated goals, if implemented, are all good news to combat global warming.
Oil and gas companies on both sides of the Atlantic are commercial enterprises, and as such, they want to make profits to support their employees and reward their stock holders and owners. These companies are producers and sellers, not consumers, of oil and gas. They will produce and sell oil, gas or any other energy commodity as long as there is a huge demand for it. Therefore, the demand side will remain a more important factor in the future of oil and gas.
We often think of oil as a commodity that is found and produced by geologists and engineers and flows smoothly to our cars and factories. But oil is intertwined with so many facets of our society. Oil geopolitics, business, policy and economy will probably be more significant areas in the post-pandemic world than geology and engineering, for there is no shortage of oil and gas but many complexities of politics and finance.
About the author…
Rasoul Sorkhabi is a research professor at the University of Utah and a former editor of Oil Industry History. He is currently working on a book on oil and OPEC. He is also a contributing editor for GEO ExPro and his articles are accessible on this website.
