The global oil price has crashed, mainly as a result of the coronavirus (COVID-19), and earlier in the week hit lows not seen for two decades, of around $20 a barrel for WTI and $24 for Brent crude. Reductions in the global mobility of passengers and goods, along with the closure of businesses, offices and schools, and the cancellation of conferences and public events, in an effort to control the virus, have led to a reduction in the demand for oil by 10 million barrels a day (10% of total liquids production). Indeed, it is thought that 2020 may be the first year in a decade that demand for oil will actually shrink. The current oversupply of oil has been compounded by Saudi Arabia’s decision to launch a price war with Russia, to which end it has slashed its oil export price, and Saudi Aramco has received a directive from the Ministry of Energy to increase maximum sustainable capacity to 13 million barrels a day. Russia too, has promised to increase its output of oil.
While the current overall curbing of activity has led to reduced carbon emissions, the economic consequences are likely to be severe. For example, it has been predicted that reductions in air travel could cost the aviation industry $100 billion, and that bailouts might be necessary to keep it going. Reduced demand for transportation fuels, and hence the oil they are refined from, will magnify the oversupply of oil to the global market, meaning that the prospects of a price recovery in 2020, back to the $60 it was trading at in January, are looking vanishingly small.
How this finally plays out, is partly a game of endurance between Saudi, Russia and the US, but once one gives in, the oversupply of oil may begin to ebb. Cost elements are complex, but while Saudi can produce oil at under $10 a barrel, it needs $85, as a fiscal breakeven price. With deep pockets, the kingdom may well hold out for longer than the US frackers, who need more rapid returns, of nearer $50, and may struggle to withstand a prolonged far lower oil price.
The importance of oil to society cannot be overemphasised, as is highlighted by a recent report commissioned by the Finnish government, which proposes that crude oil should be regarded as the most important member of the EU’s “Critical Raw Material” list. To stress, “‘Critical Raw Materials’ (CRMs) are those raw materials which are economically and strategically important for the European economy, but have a high-risk associated with their supply.”
The majority (71%) of the growth in oil production since 2005 is from light tight oil, induced to flow out of shale by the process of hydraulic fracturing (“fracking”), and in 2018, this accounted for 98% of global oil production growth. Hence, the security of the overall global supply of oil, and its ability to meet increasing demand, depends critically on the durability of the shale industry. When all unconventional sources are considered, including oil sands and kerogen shale, it is not that there is a lack of “oil” in the ground, but that it is increasingly expensive, both in terms of energy and money, to bring it to the surface in useful form.
Low oil prices discourage investment in new production, meaning less new oil coming on stream, year on year, to make up for lost existing production. A sustained low oil price through 2020 and beyond, would act as a further brake on investment, and may derail the fracking industry.
In all probability, the oversupply, at least to the present degree, is temporary; to be followed by rising prices, as the decline in existing conventional production progressively enlarges. However, a stalling of the fracking industry could cause a dramatic contraction, since as noted, rising demand growth has been met primarily through its output.
Meanwhile, a perfect storm rages, with reduced oil demand and oversupply tearing away from one another to enlarge the excess of oil, in a complex nexus of geopolitics, resources, economics, and an all-out struggle to combat the globally assailing COVID-19 virus. How, when, or if, the global economy will be restored even once the virus is vanquished remains to be seen. Businesses cannot simply be “switched back on”, having been in the doldrums for a period of months, or closed altogether.
And against this backdrop the urgency to ameliorate climate change persists. The Executive Director of the International Energy Agency, Fatih Birol, is quoted as saying, “We should not allow today’s crisis to compromise the clean energy transition.” He further expressed some optimism that due to the much cheaper renewable technologies now available, along with significant progress in electric vehicles having been made, and a financial community that is supportive of the clean energy transition, there are opportunities to be had, so long as the right policies are implemented.
However, time is of the essence, and the longer term effect of the overall systemic shock we are currently experiencing is by no means clear.