DA NANG – Global oil markets received the price war truce they had long sought, but hopes for a significant and sustained rebound in prices are still likely misplaced.
OPEC+, the group of oil producers led by Russia and Saudi Arabia, respectively the world’s second and third largest crude producers and top two exporters, reached a tentative agreement to trim oil production by 10 million barrels per day (bpd) to help ease the economic impact of the coronavirus crisis on global demand.
The group of producers will cut 10 million bpd worth of production in both May and June, then drop the cut to 8 million bpd for the rest of the year. Starting in January 2021, production cuts will drop to 6 million bpd and last until April 22, 2021.
The deal, as Asia Times reported, did not include other non-OPEC+ producers like the US, the largest global oil producer (at least for now), but OPEC kingpin Saudi Arabia called on other producers to also cut production.
The push by both Russia and Saudi Arabia to have the US join a production cut, however, may have been over played since oil prices are so far beneath most US shale producers’ breakeven production costs that around 3 to 4 million bpd of US production could go offline soon.
That will be bonus for troubled oil markets drowning in a glut of overproduction, but a whammy for the US energy sector, which is now expected to see massive layoffs at a time when unemployment claims are fast-rising due to the impact of the Covid-19 crisis.
The production-slashing deal only gave a brief respite for oil prices. In the past, a 10 million bpd oil production cut would have seen oil market bulls raging, but the day of the announcement, April 9, ended in a market tailspin.
After briefly spiking on the news, prices headed south again. Global oil benchmark Brent crude prices dipped 4.1% to close at US$31.48 per barrel. Prices for US oil benchmark West Texas Intermediate (WTI) crude also tanked by $2.33 per barrel, closing at an anemic $22.76, a precipitous 9.3% single-day decline.
Twin impactful dynamics
Despite the attention given to the OPEC+ deal, the most profound problem remains crashing global oil demand due to the economic impacts of the coronavirus.
“Ultimately, the size of the demand shock is simply too large for a coordinated supply cut,” Goldman Sachs said on Wednesday (April 8), a day before the oil production deal was reached.
Forecasts for the economic impact of the coronavirus on the global economy and hence oil demand vary, but most analysts have upped their estimates since just last week. Much of that demand destruction will be seen this month, the forecasts show.
Rystad Energy, an consulting and business intelligence firm, estimated in an April 8 note that oil demand in April will be around 72.6 million bpd, a decline of 27.5 million bpd from the same period last year, representing a 27.5% drop.
The consultancy projects that May demand will drop by 19.1 million bpd, to 79.9 million bpd, a 19% plunge.
One of the largest contributors to global oil demand destruction is the failing airline industry with the grounding of most international and even domestic flights.
Cuneyt Kazokoglu, director of Oil Demand at London-based Facts Global Energy (FGE), says jet fuel represents up to 8% of total global oil demand, which last year averaged around 99.5 million bpd.
“Even if global jet fuel demand falls by 50%, this corresponds to 4% of oil demand, or 4 million barrels a day,” Kazokoglu said.
The second systemic problem for oil markets is concerns oil storage capacity. Even if 10 million bpd worth of production is removed via an agreed output cut, storage levels will still fill up, just at a slower pace.
Moreover, a 10 million bpd cut may cause markets to briefly stabilize more than if markets were allowed to equilibrate through forced production shut ins, which started already this week in Canada. The OPEC+ deal will thus only postpone the inevitable by around a month or so.
Even after the economic impact of the coronavirus subsides, it will take considerable time, how long is anyone’s guess, for global oil demand to reach pre-pandemic levels. While oil and gas markets long for better economic times, it will likely receive help from a surprising source: renewables.
Pre-pandemic, renewables were making inroads into global energy markets that had so-called “Big Oil” nervous, as investors called for cleaner carbon footprints and energy companies that failed to get into line suffered political and social fallouts.
In May, typical of the growing sentiment, activists blockaded all entrances to the BP headquarters in London, demanding an end to all new oil and gas exploration. In March, BP agreed to work with shareholder group “Follow This” to prepare a climate resolution plan in time for next year’s annual general shareholders meeting.
Others were also following suit. In January, French-based oil and gas major Total SA announced a long-term plan to develop clean renewable assets and take current worldwide renewable energy capacity of 3 gigawatts (GW) to more than 25 GWs by 2025.
The International Energy Agency (IEA) said in October that renewables were headed for considerable growth. The Paris-based agency said that renewable power capacity was set to expand by 50% between 2019 and 2024 led by solar photovoltaic (PV) initiatives.
This predicted 1,200 GW increase was equivalent to the total installed power capacity of the US in 2019. Solar PV alone accounted for almost 60% of the expected growth, with onshore wind representing one-quarter.
However, in the new Covid-19 era, renewables are expected to waffle in the coming years since many projects also need government backing and assistance to be viable.
Most Western democracies are currently burning red ink to fund their economies to get throught the Covid-19 crisis, spiking what were already hefty debt levels.
Consequently, many countries will simply be unable to afford to back renewable projects, even as both solar and wind were becoming more cost efficient, achieving economies of scale, and were increasingly being included in many countries’ power development plans.
The loss of financial support for renewables will cause them to cede their growing market share back to oil and gas producers. This will be good news for global oil majors and their price war ravaged balance sheets, and bad news for the environment and activist investor causes.