Pandemic pushing oil sector to the brink

Paran Balakrishnan | Updated on March 31, 2020 Published on April 01, 2020

With prices set to fall further, oil giants are slashing budgets   -  Getty Images/iStockphoto

The slump in oil demand — thanks to lockdowns and travel advisories — will be a game-changer for the sector

It’s been a price meltdown that looks set only to worsen for the oil industry as Covid-19 pandemic slams demand. On Monday, the price of West Text Intermediate crude slid below $20 a barrel before clawing back slightly. International benchmark Brent Crude was still hanging in there at $22.76. Global oil giants now believe prices could plunge another 20-25 per cent as demand keeps falling amid lockdowns worldwide aimed at containing the highly contagious coronavirus.

It’s hard to believe oil was $65 a barrel when we entered the new decade just three months ago, climbing back to $70 days later. The Chinese ushered in this period of gut-wrenching change for the oil sector January 23 when it closed roads leading into Hubei province. By end-January, the world began comprehending the grim news emerging from China and it all began to unspool for the industry. Oil slipped below $60 and then went into precipitous free-fall.

In the meantime, there’s been the side-show of the battle between Saudi Arabia and Russia about production levels which has unmoored the sector further. On the surface, it’s appeared Saudi Arabia and Russia, which struck a deal back in 2016 to limit output and keep prices around $70, had fallen out. Many Americans, though, see a conspiracy afoot between their erstwhile Saudi buddies and Russia to reduce prices to levels that would wipe out the US shale industry.

Ted Cruz, the senator from Texas and former Republican presidential candidate, certainly is one person who believes the Saudis and Russians have stepped up pumping oil just to squeeze the US. He and other senators recently let the Saudi ambassador to the US know exactly what they thought of her country. “We quite frankly unloaded on her,” said Cruz, without bothering to sugar-coat his words. In 2018, the US became the world’s largest oil producer and suddenly it wasn’t as dependent on the House of Saud as it has been.

As for the Russians, they’re still smarting about sanctions the US has imposed on them. Last August, the US stepped up its squeeze on the Russians and imposed a second round of sanctions. This move aggravated the pain for Russia’s already badly struggling economy, leading the Russian rouble to tumble steeply.

The Saudis, too, have been harbouring resentments, having done the lion’s share of output cuts to ensure prices stayed up which allowed the US to grab the global top producer title.

US Secretary of State Mike Pompeo appealed to the Saudis last week just before a G20 video-call, to let things return to normal — well, as normal as they could be under Covid-19 circumstances. But the Saudis said no dice, they weren’t even in talks with Russians.

In the cross-hairs

Even if the Saudis and Russians do indeed kiss-and-make-up, it’s “irrelevant” Goldman Sach says after what the investment bank calls “the largest economic shock of our lifetime… which has put carbon-based industries like oil in the cross-hairs.” Lockdowns, social distancing and travel advisories now affect 92 per cent of the world’s GDP, Goldman Sachs estimates.

Consider that in India alone international flights mostly stopped some time ago and domestic ones took off for the last time last Wednesday. Simultaneously, railways aren’t running passenger trains and all private cars are perforce off the roads. Even trucks, which should be ferrying essential commodities around India, are stalled because they can’t cross State borders. Many vehicles have been abandoned by drivers who have no roadside restaurants or anywhere even to get water.

As prices fell, countries like India had been buying big quantities. But now, everyone’s emergency storage tanks are almost full. “No-one can exactly be sure production will be shut-in fast enough not to overwhelm our ability to store oil,” said one energy market consultant.

Global oil-makers may have to have a rethink given the storage problems. But what’s called the OPEC+ (OPEC plus allies) agreement to keep a leash on supplies expired on March 31 and there are indications even now some producer countries might step up pumping. Saudi Arabia had earlier announced it would push up pumping to around 10.6 million barrels daily, a sizeable jump from its current seven million barrels daily.

That brings us back to Covid-19 and how it’s trashed demand for oil globally. Goldman Sachs forecast oil demand will fall another 25 per cent and won’t recover in a hurry. A coordinated supply response to unfolding developments is “impossible to achieve in time,” said the bank.

As the lockdown went into force, in India, petrol sales fell to 45 per cent of earlier demand levels. Diesel demand slumped 40 per cent. Companies like Indian Oil predict demand will drop further as we go into the second and third weeks of our 21-day lockdown. Aviation turbine fuel sales have dived because of the grounding of all commercial flights.

It’s much the same story across Europe where many countries are under total or partial lockdowns. And, as India’s market collapses, Indian Oil is reported to have declared a “force majeure,” telling suppliers it can’t lift oil it contracted to buy. It’s also cut its refining capacity by around one-third.

Falling oil prices have traditionally been a boon for energy-starved India — though consumers won’t be cheering at the gas stations because the cash-strapped government has smartly decided to pocket the windfall by hiking taxes.

Collapsing demand has also taken a toll on share prices. Reliance’s share price has nosedived by 40 per cent from February highs. And, of course, the turmoil in the oil market makes its Aramco deal even less likely than before.

What’s in store?

What’s the future? Right now, energy consultant JBC says it’s looking at Brent prices “to briefly go to $10 per barrel as it was back in 1986 or 1998.” Right now, oil giants are axing budgets. Exxon announced Monday it’s cutting production. Longer-term, Goldman Sachs sees a big industry shake-out with global oil demand from airlines and the commuter sector possibly never returning to pre-Covid-19 levels.

“Big Oil will consolidate the best assets in the industry and will shed the worst,” the investment bank said in its note to clients. “When the industry emerges from this downturn, there will be fewer companies of higher asset quality, but the capital constraints will remain.”

What seems certain is this roller-coaster of events is a game-changer for the sector. On the plus side, though, the oil price crash has made returns from investments in renewable energy projects like wind and solar that now are the cheapest sources of power to build look much more attractive — and that can only be a good thing.

Published on April 01, 2020

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