Oil and gas sector: Covid-19 will affect oil and gas prices even in the medium to long term

While the oil and gas industry had already been weakened a few years ago by the steep decline in oil prices that had started mid-2014 and made prices evolving at a lower level since then, the sector faced a new brutal double shock in the first months of this year: (i) a sudden and massive drop in global demand following the covid-19 outbreak, with crude oil consumption cut by almost a third as compared to its peak and expected to be about 8% lower on average this year than last year, according to the International Energy Agency (IEA), and (ii) an oil market-share war between Saudi Arabia and Russia launched in March. The combination of the two factors led the price of the Brent crude oil benchmark to collapse by more than 70% between January and April (cf. graph 1). In the meantime, oil prices rebounded thanks to the record cuts in production decided by the OPEC+ group, who struck a deal to reverse the trend of the price battle, and to declines from other large producers such as the USA and Canada. Lockdown measures were also progressively eased in major oil-consuming countries, allowing a partial return of demand. However, despite the recent recovery, crude oil is still trading today at about a third below last year’s average price. As for natural gas, according to the IEA, demand is expected to fall by around 4% this year on average, which would constitute one of the largest contractions ever registered by the sector. Gas prices are at a low (cf. graph 1), especially in Europe, due to large oversupply already in place before the virus outbreak.

Oil and gas producers’ recent second-quarter financial results reflect this damage, with global supermajors posting huge losses and writing down assets. IHS Markit forecasts the oil and gas industry’s gross profits to drop by almost 40% this year. Deep spending and CapEx cuts point to a sector willing to consolidate balance sheets. The IEA estimates a decline in oil and gas investments of around one-third in 2020 compared with the previous year.

Short-term perspectives circled by huge uncertainties

While in the short term, the evolution of the sanitary crisis and its impact on demand will be the major drivers of the evolution of prices, other factors, like the decisions by the OPEC+ group regarding production, large production disruptions (e.g. provoked by natural disasters or wildfires) or a possible increase in the US-China tensions could influence them as well. As for gas, the seasonality in prices should exert an upward pressure with the return of cooler temperatures in the northern hemisphere but the prices should remain low due to a large oversupply situation and they too will very much depend on the sanitary evolution and its implications in terms of demand for electric power. On average, energy prices are not expected to be concerned by great trends upwards in the next few months.

Oil demand peak should be reached sooner than previously anticipated

But the outbreak of the covid-19 will also definitely affect the future course of oil demand and supply in the medium to long term. First of all, the demand for refined fuel products will likely remain depressed in the next five years, as the transportation sector will continue to be affected for some time. Social distancing behaviours and remote working practices are likely to stay in place while business trips could take quite a long time to get back to normal, even after the distribution of a vaccine. Secondly, some massive coronavirus stimulus packages from developed economies involve climate-friendly recovery measures, which should modify the energy supply patterns weighing on traditional fossil fuels. For instance, the European Commission made climate programmes a centrepiece of its recovery effort while the IEA, in collaboration with the IMF, elaborated last June a green recovery plan involving a scenario with a broad shift to clean power. The latter would result in a decrease of oil consumption in transport of around 2 million barrels per day (2% of the global pre-covid-19 crude oil demand). Obviously, these plans assume investor groups will step in.

As for natural gas consumption, the impact of the coronavirus outbreak on the long-term demand is less clear than for oil, as natural gas is foreseen to be a contributor to the energy transition. Natural gas demand should continue to increase in the coming decades. The central US Energy Information Administration scenario, which was elaborated in 2019, forecasted a 50% increase by 2050, driven by the industrial sector demand in non-OECD countries. In its recent Energy Outlook, BP estimates that, even in the Rapid Transition Scenario, demand for gas will still grow in the next 15 years.

National and international policies will remain the major drivers of the evolution of energy demand in the medium to long term but the covid-19 outbreak has definitely increased the blur related to its trajectory and brought the demand peak closer in time.

Diminished investments could weigh on supply

Theoretically, the global oil and gas industry is able to fulfil the growth in demand, whatever it is, in the long term, thanks to sufficient technical recoverable resources. This represents an important shift in paradigm from the one that dominated oil markets over the past decades and according to which oil was to become increasingly scarce in a foreseeable future. Supply peak was then thought to be reached before the demand drop became constraining.

Nonetheless, temporary imbalances between supply and demand in one direction or the other are frequent, as individual or group of producers adapt their production not only to the demand and prices, but also to geopolitical interests and to economic and political objectives. In addition to capacities that can easily be put on the market, investment decisions impact future production and, in that regard, current CapEx cuts by oil majors should weigh on future supply and help to counterbalance somehow the coronavirus-induced loss of demand.

While the peak in oil demand was not foreseen to happen before 2040 according to reasonable scenarios elaborated before the covid-19 outbreak, the pandemic-related consequences in terms of demand and policies let augur a sooner happening of this. Oil and gas companies, weakened by the low level of prices and their volatility and pushed by investors increasingly eager to step in cleaner projects, could consider – more than before – participating actively to the energy transition and turn to products more sustainable than fossil fuels. This is actually a trend which is mainly observed among European oil and gas companies. Structural changes in the sector are therefore foreseen.

Analyst: Florence Thiéry – f.thiéry@credendo.com