The Future of Oil in the Wake of the Covid-19
For some, the painful memory of waiting in long lines for limited gasoline in the 1970s is still alive. However, the negative oil prices in 2020 in the midst of the COVID-19 pandemic are sending one message: the oil era may never come back.
The unprecedented health crisis has proved to be a life-changing challenge for many industries, but the oil industry was especially hit hard. Back in February, lockdowns and travel restrictions have caused declines in factory output and reduction in travel. As the pandemic continued to spread, more and more countries began imposing constraining measures and the demand for oil fell even further. Facing the downward pressure of oil prices, in early March, OPEC countries aimed to cut oil productions with Russia. Russia refused to do so and Saudi Arabia offered record-low prices to its customers in response to that, finally leading to a slump in oil prices and ending with the first negative oil prices in history in April. While eventually the OPEC+ agreement was reached, such an oil crisis has sparked discussions about the future of the commodity. Will the crisis only be a temporary phenomenon, or will there be a permanent change for oil producers? Only time will tell, but from the analysis of this article, the change may be structural and permanent.
Oversupply meets with sluggish demand growth
The golden era for petrostates has gone. This is almost a fact if we compare the oil crisis this time and the ones before. In the 1970s, later in the early 2000s until 2014, oil producers could act collectively to cut their productions in order to get higher prices and to achieve political influence. In recent years, this strategy was no longer effective because of the improved energy efficiency, growing popularity of clean energy and most importantly, the technical breakthrough in U.S. shale oil. The discovery of shale oil and surging production has fundamentally changed the scarce supply of oil, which has long been a powerful tool of traditional petrostates. Limiting oil production was replaced by dumping oil supply and gain more market share. Oil exporting countries also started to put diversifying their economies on the agenda. The supply of oil will continue to be more than sufficient if no big supply disruptions happen because of conflicts and political upheavals. In the meantime, demand-side will face sluggish growth in the long run. While demand declines caused by the 1997 and 2008 financial crises were temporary and rebounded later to push the demand even higher, this time the demand may never rebound to the pre-crisis level. Climate change, the fact that natural disasters happened more and more frequently combined with the health crisis and the following economic disruption have inspired people to think more seriously about our relations with the planet. And because of the easy spread of the virus, travel needs cannot fully recover to the previous level for quite a while. Consumer willingness and confidence in buying new cars, especially traditional cars may stay low too. Car sales in the EU fell 55% in March compared with last year. In February, the sharp decline of car sales in China was 82% from 2019 level. Such a dramatic drop in car sales in an emerging market like China is more telling in deciding the future of cars and thus of fossil fuels as the need for cars has become almost saturated in the developed world and as mobility accounts for about 57% of global oil demand. Therefore, the imbalance between supply and demand for oil will still exist even after the pandemic. oil prices will recover to some degree, but the high prices enjoyed by oil producers will just be the past.
Financial hardship for oil producers combined with new momentum for renewables
As a result of the unprecedented low price of oil, oil companies around the world have experienced shut-ins. While the physical shut-ins are easy to conduct, the expenses related to shut-ins and uncertainties after closing and reopening of the wells may be costly and will hit the oil producers who have been put in financial difficulties even harder. Especially for U.S. shale oil, according to a recent report by Deloitte, if the oil prices remain at $35, 30% of producers will be insolvent and 20% will face severe financial challenges. As the COVID-19 cannot disappear in a short period, and so as the low oil prices, such financial hardship will cause lots of bankruptcies and change the path of this industry. In the U.S. alone, 225 bankruptcy cases are pending as of the end of May, and the scale of bankruptcy from April through June was the highest in a quarter since the 2016 oil crash, according to a report by law firm Haynes and Boone LLP. In contrast, renewables have gained new momentum during this pandemic. Sales of electric vehicles rose to record shares in many EU countries. As governments around the world are rolling out new economic packages, many of them may seize this opportunity to end fossil fuel subsidies and direct investment in clean energy, accelerating their energy transition. In fact, structural reform in the energy sector will come ultimately. The cost of solar PV has been falling due to technological advances and has attracted more and more investors. The shift of capital from fossil fuels to renewables combined with government support will once again prove the end of the oil era.
Looking back in history, the oil industry has experienced its golden era for decades. But now, it has passed its prime age and it is time for clean energy. The plummet of the oil industry may in large part, because of this health crisis, but when everything goes back to normal in the future, the oil industry may not.
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