Five ways the coronavirus changed the world of energy this week
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A week ago, a crowd of 68,000 cheered Al Boum Photo to victory in the Cheltenham Gold Cup. Rod Stewart played the 159th show in his long-running residency at Caesar’s Palace in Las Vegas. Walt Disney World was thronged with happy holidaymakers. And thousands of people were getting ready for a weekend of dancing and drinking in downtown Nashville. Today, those seem like memories from a vanished time, as communities across the US and UK impose shutdowns and call for “social distancing” to limit the spread of the new coronavirus.
For the oil industry, the impact has been magnified by the failure of the OPEC+ countries to agree on collective production cuts to help balance the market. Brent crude, which began the year at about $66 a barrel, was trading at $28 on Friday morning.
In a sign of these turbulent times, Mohammad Barkindo, secretary-general of OPEC, and Fatih Birol, executive-director of the International Energy Agency, took the unusual step of issuing a joint statement on Monday, warning that the slump in oil prices could have “major social and economic consequences” for vulnerable developing countries.
Here are five of the key developments for energy in what has been another dramatic week.
1. The US government is buying oil
As the US Congress and the administration debate stimulus plans intended to counteract the economic shock from the pandemic, one sector that has already been singled out for special help is the oil industry, although the aid is not wildly generous. President Donald Trump last week announced a plan to fill the spare capacity of 77 million barrels in the US Strategic Petroleum Reserve. On Thursday, the Department of Energy announced the first instalment of that purchase, sending out a request for proposal to buy 30 million barrels.
Based on a WTI price of about $25 a barrel, the first instalment will cost about $750 million. The department is asking Congress for $3 billion to fund the purchase programme, implying it could pay an average price of about $40 a barrel. Mark Menezes, the under-secretary of energy, said the administration was “taking swift action to assist hard-hit producers and deliver strong returns to the taxpayer” by buying oil at low prices. Since 2015, both Congress and the administration have supported selling oil from the SPR to raise funds for other purposes such as ensuring the storage sites are in good working order.
The department said this week it would buy crude only if it was “produced in the United States by United States producers”, in an attempt to target the benefits on the domestic industry. Oil is broadly fungible in the global market, so most of the effect of the intervention on crude prices will be shared by producers worldwide. However, the department’s announcement did help close the differential between WTI and Brent by about $1.50 a barrel.
Although the purchases will help provide some support to the market, they should be kept in context. At the beginning of the month, OPEC member countries hoped to secure agreement with Russia on a 1.5 million barrel per day output cut until the end of the year, which would have taken more than 400 million barrels off the market in total. Filling the US SPR completely would take about one-fifth of that.
There is also a constraint on the purchases because the SPR includes a mix of both the sweet crude typically produced from US shale reserves and sour grades. The first batch of purchases is divided between 11.3 million barrels of sweet and 18.7 million barrels of sour crude, further limiting the benefit for US shale producers.
2. There are calls in the US for a more managed oil market
OPEC has often been attacked in the US for distorting the oil market to keep prices up, but it is now being criticised for allowing prices to fall. The Wall Street Journal reported that the Trump administration was considering trying to use diplomatic leverage with Saudi Arabia and sanctions against Russia to encourage them to cooperate to stabilise the market. However, President Trump himself indicated that while the US was indeed trying to help the two sides reach agreement, no-one should expect any immediate progress. “They’re in a fight on price, they’re in a fight on output,” he said on Thursday. “At the appropriate time I’ll get involved.”
Senator Kevin Cramer from North Dakota and 12 other Republican senators from oil-producing states including Texas, Alaska and Oklahoma this week wrote to Crown Prince Mohammed bin Salman of Saudi Arabia, urging his country to “halt its recent efforts to boost oil production and lower crude oil prices”. Cramer later wrote to President Trump urging him to impose an embargo on imports of oil from Russia, Saudi Arabia and other members of OPEC, to show that “the United States will not be bullied or taken for granted”.
The WSJ reported that the Railroad Commission of Texas, which regulates oil and gas production in the state, was considering imposing new restrictions on output, following requests from oil executives. Managing US oil output was one of the traditional functions of the RRC, but it has not used production controls since 1972.
Ryan Sitton, one of the RRC commissioners, whose term ends at the start of next year, wrote a column for Bloomberg Opinion in support of the idea, saying: “No-one — not the Saudis, Russians, Americans or anyone else — benefits from unstable energy supplies.” He suggested that Texas could agree a 10% cut in output, imposed on its production companies, if Saudi Arabia and Russia also agreed to 10% reductions from their pre-pandemic levels. He argued that such a move could stabilise crude prices in the mid-$30s, and “stave off a total industry meltdown”. Quotas for Texas producers now, he said, could be the right way to maintain the US role in the oil market and ultimately prevent supply disruptions when demand returns.
3. The demand shock is getting sharper
The world’s storage capacity is filling up fast with unused crude, as transport use slows sharply. The hit to demand was underlined by a series of airlines announcing announcement of capacity cuts lasting for several weeks at least. Singapore Airlines, for example, said that until the end of April it would operate only half the capacity that it had previously planned. United Airlines announced a 60% reduction for April. Airlines for America, an industry group, described the blow to their business as “worse than the financial and operational impact caused by 9/11”, and asked for a $58 billion bailout in the form of government grants, loans and loan guarantees.
The Trump administration has signalled that it backs the industry’s request, and the financial support is likely to be included in a wider stimulus plan.
4. US shale producers are responding quickly to the downturn
The plunge in the oil price threatens to put the industry under extreme financial pressure, and many companies have been moving quickly to respond. The Majors are expected to be more resilient thanks to their strong downstream operations, but even they will be severely challenged by crude in the $20s. Shares in ExxonMobil, for example, have dropped by about 50% since the beginning of 2020, while BP has dropped 55%. The world’s leading oil companies would need to cut their total spending, including dividends and share buybacks, by an average of 41% to achieve cash flow neutrality this year, even with Brent at $35, which is well above its present level.
There have been few signs so far that companies around the world are starting to shut in uneconomic production. New Wood Mackenzie calculations using our Lens database show that at a Brent price of $35 a barrel, about 4 million b/d of global liquids supply does not cover its short-run marginal cost. But in the last downturn of 2014-16, very little out-of-the-money production was shut-in, because the costs associated with a shutdown and potential later restart were too high.
We expect that in the near term, higher-cost producers will generally try to reduce expenses and keep production flowing. Fields where production is already shut-in, and there are costs to restarting, may be left offline. EnQuest, a North Sea producer, said this week it would not restart production at two mature fields that were already shut down for repairs.
Some of the sharpest share price moves have been for the US E&Ps, and those are the companies that have been the quickest to respond to the downturn by cutting costs. Continental Resources, for example, this week slashed this year’s capital spending budget from $2.65 billion to just $1.2 billion. It is cutting the number of rigs it has running in the Bakken and in Oklahoma from an average of 19.5 to just seven. Diamondback Energy, which had already announced a slowdown in activity on March 9, announced a second round of cuts on Thursday, going from running nine completion crews and 21 rigs at the start of the year to no more than five completion crews for the rest of the year and no more than ten rigs from the third quarter.
At least 10 US tight oil producers have already revised down their guidance for spending in 2020, with the cuts generally ranging between 20% and 35%. Less than 10% of the inventory of potential future wells can generate a 15% internal rate of return with WTI crude at US$35 a barrel, according to Robert Clarke, Wood Mackenzie’s research director for the US Lower 48. “So new-drill opportunities can only be in the best rock,” he added.
The oilfield services sector is also feeling an immediate impact. Halliburton this week told about 3,500 employees in Houston that they would have to work a one week on, one week off schedule, receiving no pay for their weeks off.
Meanwhile, Saudi Aramco held an investor call on Monday to present its 2019 earnings, and emphasised its resilience in tough conditions. However, it too is curbing its spending: its capital budget for 2020 is US$25-$US30 billion, down from US$33 billion last year.
One issue to watch will be whether the coronavirus starts to affect oil supplies. So far, the disruption to production has been minimal, but there have been a few reports of staff being forced to leave work. Production at the Gharraf field in Iraq was shut down this week, Reuters reported, because Petronas of Malaysia had evacuated all its staff from the project.
There have been no reports of any problems with US onshore production as a result of the virus, but Midland, Texas, the nearest city to the Permian Basin, reported its first confirmed case on Thursday, and the situation will be worth watching.
5. Renewable energy could find opportunities in the crisis
It is not only the oil industry that is being disrupted by the coronavirus. The economic downturn is hitting demand for power, the reliability of supply chains and the availability of financing, threatening to put a brake on investment in renewable energy. Not every renewable energy company is facing difficulties. Enel, the Italian power company, said this week that it did not expect the coronavirus epidemic to have any major impact on its results, Reuters reported. But many businesses are threatened. The US Solar Energy Industries Association warned this week that the sector faced a “crisis”, with installation work slowed by shortages of labour and components. The US renewable energy, storage, efficiency and electric vehicle industries are urging Congress to extend their tax breaks and other support.
The pandemic is a threat to alternative energy in other ways. Low crude prices, if they last, will slow the shift away from oil by making internal combustion engine vehicles more competitive against electric cars and trucks.
The crisis is also being cited as a reason for easing up on policies to cut emissions. Politicians from Poland and Czechia have argued that their countries should be exempted from the EU’s emissions trading programme, or that the union should set aside its ambitious 30-year strategy for cutting emissions, the European Green Deal.
Fatih Birol, executive-director of the International Energy Agency, argued that governments around the world had a “historic opportunity” to support low-carbon energy investment in their economic stimulus packages, but risked throwing it away. He warned: “The combination of the coronavirus and volatile market conditions will distract the attention of policymakers, business leaders and investors away from clean energy transitions”.
However, Wood Mackenzie’s Valentina Kretzschmar explained why the chaos in the oil market could end up being good news for renewable energy. One reason for oil and gas companies not to invest in renewable energy has been that the returns in solar and wind projects have offered much lower rates of return than upstream oil and gas. At today’s crude prices, that is no longer true. “Capital allocation is no longer a one-way street for Big Oil,” she wrote. “Renewables projects suddenly look as attractive as upstream projects at US$35 a barrel”
And finally: at a time when people in many countries are forced to isolate themselves, life offshore might looks like a rather more attractive proposition, and the French architecture firm XTU has come up with some cool concept artwork showing oil and gas platforms repurposed as living spaces. None of their visualisations look remotely practical, but they might be fun for entertaining dreams of becoming a Bond movie villain.
Quote of the week
“This sector is now in a paper-thin position… Action is needed now to ensure the sector doesn’t lose the skills, experience and infrastructure it needs to meet the UK’s energy needs of today as well as help deliver its net-zero ambitions in future.” — Deborah Michie, chief executive of Oil & Gas UK, warned that the coronavirus pandemic and oil price crash threatened to do severe and lasting damage to the UK’s offshore industry.
Charts of the week
As Italy has introduced an unprecedented lockdown in an attempt to control the alarming spread of the coronavirus and the rising death toll from Covid-19, the impact on its demand for energy is already becoming apparent. Electricity consumption has already fallen sharply, and these charts show a similar decline for gas. Wood Mackenzie’s analysts say that purely from the lockdown, if it lasts for three months, Italy’s gas consumption will be about 3 billion cubic metres lower in 2020. It is usually about 70 bcm. That is assuming the economy bounces back quite quickly after the lockdown lifts. If the economy sinks into recession, then the fall in gas demand will be even sharper.