Oil price crash - where does Asia go from here?
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2020 has hit us like a fist. Coronavirus is already the most severe shock to hit the world economy since the financial crisis over a decade ago. A dramatic ramp-up in containment measures is having a negative economic effect and weaker GDP growth, and potentially global recession, in 2020 is now a reality.
Oil demand has gone into a tailspin. We now expect Q1 global oil consumption to be 2.7 million b/d lower than the same period a year ago. The response from the OPEC+ group was carnage as the two largest producers, Saudi Arabia and Russia, squared up for a price war. Oil prices inevitably fell off a cliff, with Brent testing US$30 per barrel.
Energy companies across Asia Pacific are now grappling with how to respond to multiple events; a precipitous loss of demand from the coronavirus outbreak, near-total uncertainty over how long and how severe the future effects will be, and the dramatic re-setting of energy prices in the wake of the oil price crash.
Upstream investment in Asia Pacific on hold
There is no doubt that lost demand and sustained prices below US$40/bbl must mean a new wave of brutal industry cost cutting. Discretionary spend will be slashed. Given the lack of excess in the system, cuts will necessarily be fast and deep. US tight oil is the obvious focus, but companies across Asia Pacific are also being forced to react.
Our APAC Exploration team had been expecting around 200 exploration wells in region in 2020. This could now fall by up to 30%. Most explorers will delay campaigns where a rig has not yet been committed or if the well economics at US$35/bbl fail company thresholds. As a result, exploration spend will shrink, falling by up to US$1 billion from an expected level of US$4.5 billion this year.
Currently, only around 16% of future prospects in APAC breakeven below US$35/bbl, and most of those are smaller near-field prospects. With less wells drilled, Asia can expect a rising import requirement in future years.
A shift back to survival mode will make 2020 FIDs challenging
A sustained period of low prices will delay most upstream FIDs in the region. With companies prioritising short-term cashflow, the ability to fund and willingness to undertake new capital-intensive projects will come under scrutiny. In the current climate, E&P companies must bolster their balance sheets to survive a prolonged low oil price.
The biggest blow will be felt in Australia where companies are aiming to sanction large, strategically important backfill LNG investments in 2020. Significant projects in Southeast Asia will also be pushed back.
Among those projects targeting FID in 2020, Australia’s Scarborough (Woodside operated) and Barossa (Santos operated) account for 52% of unsanctioned spend and 48% of reserves. Prior to the oil price crash, Santos and Woodside were already looking to farm-down their respective equity exposures to ease capital requirements. This will be challenging in the near-term as companies roll out capital management plans to control or delay discretionary expenditure. All projects vying for FID but requiring a farm-down in equity exposure will be challenged.
Looking across Asia Pacific, close to $35 billion of pre-FID and development spend is at risk in 2020-2022, and that’s before we consider potential cuts to existing spend on producing assets.
The impact on existing Asia Pacific oil and gas production
For existing upstream supply, the impact is more modest. The key market here is China. The country produces 3.7 million b/d, equivalent to over 60% of the 6 million b/d produced in region. On a short-run marginal cost basis, we believe all this production is safe. But this isn’t the full picture; with additional capex required to maintain development drilling on a number of mature projects, some 700,000 b/d of Chinese crude is currently ‘out-of-the-money’ at US$35/bbl oil.
But that doesn’t mean we will see those volumes shut-in. During the last downturn higher cost fields were eased down, and output fell to preserve capital. This time round, the situation is far more complex. As China slowly gets back to work following the worst of the coronavirus, the Chinese NOCs are under intense pressure to ramp up activity, supercharge spend and give the economy all the help they can.
How will national oil companies respond?
Asia’s NOCs are the region’s largest producers and how they adapt to lower oil prices will have repercussions beyond volumes. Governments rely on these companies for tax revenues, employment and energy import decisions. How the NOCs react to this crisis will determine the regional outlook for the oil and gas sector for years to come.
As with the Chinese NOCs, I expect few Asian national companies to change their spending plans for 2020, despite lower prices. Governments are looking to state-owned enterprise to maintain economic activity and employment, suggesting spending will continue as planned. Any possible divestment programmes will now be put on hold and, despite a tremendous market opportunity, counter-cyclical M&A is unlikely. Domestic operations will be prioritised over international investment.
Petronas and ONGC have already stated they will not change direction in 2020 and, as discussed, I think we can expect a similar message from the Chinese NOCs. For PERTAMINA and PTTEP, of more immediate concern will be managing the operatorship transition of strategic assets Rokan and Erawan. Any disruption to investment will have a significant impact on both corporate and national production.
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Asia’s refiners able to optimise crude supply, but a lack of demand means continued weak margins
The oil price crash comes at a challenging time for Asian refiners. Margins and crude runs were already taking a beating as coronavirus hit demand.
Any prospect of global oil demand growth in 2020 is clearly at risk, mainly from weaker demand outside China now that coronavirus is a global pandemic. Historically, low oil prices stimulate oil demand, but the extent to which low oil prices will help demand to recover this time is limited by obvious coronavirus containment measures. Upside in refining margins is contingent on a recovery in oil demand.
In addition to coping with weaker oil demand, refiners are now adapting to lower oil prices and a large increase in OPEC production starting in April. From next month, Saudi Arabia will slash its official selling prices to Asian refiners by US$4-7/bbl to protect market share against competing crudes from the US, Russia and Africa.
A large increase in OPEC crude will lead to a wider crude price differential between Dubai and Brent. This is advantageous for complex and deep conversion refiners such as Reliance and Nayara Energy in India and Sinopec and PetroChina in China. In the current environment of high oil product inventories and lower margins, refiners will be more selective on the crudes they process to gain advantage on refining margins.
Despite this, with limited prospect of any rapid recovery in demand we expect refining margins to remain weak over the next few months.
Is there upside to LNG demand from low oil prices?
Asia Pacific gas demand was already under pressure as coronavirus impacted consumption in China and continued downside is expected as the world struggles to contains the virus. Low oil prices are a mixed blessing for LNG markets. Sustained lower oil prices will bring down LNG contract prices in Asia, which have been at a premium recently, but also create greater competition from oil itself.
In Japan and South Korea, lower prices for oil-indexed purchases should support coal-to-gas switching economics in the power sector. South Korea has seen some switching in recent months. High oil-indexed contract volumes dominate the weighted average cost of gas, resulting in strong 2019 prices around US$10-12/mmbtu. But with the oil price fall, prices are set to halve over the next three to six months, bolstering the case for gas (though competition from coal will remain intense).
For China, at US$35/bbl oil, contracted LNG arrives at a lower cost than domestic wholesale price benchmarks. While there is strong incentive for NOCs to retain the benefits, the import cost reduction will be partially passed through and allow the government to push lower gas prices to end-users. This will help coronavirus-affected business resume operations but stimulating new coal-to-gas switching will still require further policy support.
In other markets, gas demand will come under pressure. Notably in India, lower oil price could slow the shift from oil to gas in the industrial sector, as heating oil, LPG and naphtha compete with contracted and spot LNG.
APAC Energy Buzz is a blog by Wood Mackenzie Asia Pacific Vice Chair, Gavin Thompson. In his blog, Gavin shares the sights and sounds of what’s trending in the region and what’s weighing on business leaders’ minds.