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ECONOMIC TRENDS Oil Markets in the Post- Covid-19 World Mohammed Hamdaoui September 2020 (1) Economic TRENDS (1) Oil Markets in the Post- Covid-19 World Mohammed Hamdaoui September 2020 Views expressed in this study do not necessarily reflect that of TRENDS Research & Advisory © All publishing rights reserved First edition 2020 Order No.: MC-02-01-8774073 ISBN: 978-9948-25-112-5 All copyrights are owned by the publisher. This book or part thereof shall not be reproduced in any form, translated or quoted from without prior written permission of the publisher. These rights are reserved worldwide. All registration and protection procedures have been taken in accordance with international copyright treaties for the protection of literary and artistic works. © Trends Research & Advisory http://trendsresearch.org About TRENDS Research & Advisory TRENDS Research & Advisory was founded in Abu Dhabi in 2014 with the objective to be an independent research center positively contributing to enhancing scientific studies. The Center seeks to provide a better understanding and deeper analysis of the developments and challenges impacting the Gulf and Middle East regions and the world in general. Conducting research at TRENDS Research & Advisory follows internationally-acknowledged scientific standards adopted by the most established think-tanks worldwide. The Center has been contributing effectively toward the process of enlightening the Arab and international public, especially concerning geopolitical, economic, and security affairs. The Center seeks to continuously widen its network of researchers and experts from highly reputable Arab and international universities. The objective behind building this network is to maintain the quality of research, diversify research methodologies, and address both regional and global-wide issues from different perspectives. TABLE OF CONTENTS 1. Abstract 9 2. Introduction 10 3. Oil crises - the past and the present 11 Impact of Covid-19 pandemic on oil 4. 22 markets 5. Oil markets in a post-Covid world 31 6. Conclusion 45 7. References 47 8. About the Author 51 Oil Markets in the Post-Covid-19 World Abstract The scale of the socio-economic impact of the Covid-19 pandemic on the global economy has not been witnessed since the Great Depression. Isolation measures, implemented across the globe to contain the virus, confined hundreds of millions of people into their homes, bringing economic activities to a standstill. This crisis has impacted the oil and gas industry in an unprecedented manner. A massive decline in oil demand and a large oversupply, intensified by the price war between Russia and Saudi Arabia, has sent oil prices to levels unseen in decades. While the oil industry has faced several crises that have pushed it to find new ways to conduct business and adapt to changing conditions, the Covid-induced crisis has come when the industry is dealing with increased shareholder activism and intense pressure on the environmental front. Since this is a new phase for the industry, it could also become the catalyst that accelerates the transformation it has started to go through. Oil will continue to play an essential role in the energy mix for many decades. However, oil companies will have to navigate and manage an uncertain future as oil and gas projects will be riskier to develop and consequently require a higher rate of return. They will have to diversify their portfolios and continue shifting toward an integrated business model that embraces the changes caused by the energy transition and the growth in renewable and new technologies. 9 Introduction The world has not experienced anything like Covid-19 since the Spanish flu between 1918 and 1919. The scale of the social and economic impact of the ongoing pandemic on the global economy has also not been witnessed seen since the Great Depression. We have entered uncharted waters, and it is difficult to fathom the actual extent of the lasting impact. Various isolation measures, which the International Monetary Fund (IMF) calls “the Great Lockdown,” were implemented across the globe to contain the spread of the virus. These measures confined hundreds of millions of people into their homes, bringing economic activities and life as we know it to a standstill worldwide. The IMF predicts that the global economy will contract by 4.9 percent in 2020, but “extreme uncertainty around the global growth forecast” remains and will depend on how several unprecedented factors will evolve. The slowdown in the global economy has impacted the oil and gas industry in a way we have not witnessed before. The combination of a fast, massive, and almost instantaneous decline in oil demand and a large oversupply, further intensified by the price war between Russia and Saudi Arabia, has sent the price to levels unseen in decades. This paper will compare the current crisis caused by the Covid- 19 pandemic with the oil price crashes of 2008 and 2014-2016. It will analyze the impact of the current crisis on the oil markets and look at the oil industry’s outlook post-Covid-19. 10 1. Oil crises - the past and the present The oil and gas industry goes through cycles driven by significant shifts in demand, supply, and geopolitics. Several price collapses have varied in the drivers that triggered them, the scale and the length of the price decline, and the effects on the oil and gas industry. The industry has experienced three major price crises since the turn of the century: the first was a result of the 2008 financial crisis, the 2014-2016 shale oil boom triggered the second, and the third is the unprecedented situation caused by Covid-19. While the 2008 price collapse was driven by demand destruction caused by the major economic recession following the US financial crisis, the 2014-2016 price collapse was mainly driven by a glut in supply from the US shale oil industry. The ongoing crisis is unique because it was triggered by a massive drop in demand due to lockdown measures, travel restrictions, and reduced economic activity across all countries at varying degrees. It was coupled with plentiful supply, unavailability of storage capacity in addition to an ill-timed price war. 11 Figure 1: Brent oil prices US$/bbl1 1.1. The financial crisis of 2008 and oil demand destruction The 2008 financial crisis started in the real estate market in the US, and the ensuing great recession, which was the worse since the Great Depression, had a profound impact on the oil and gas industry at multiple levels. It caused a drop in demand, a collapse in prices, a reduction in the value of assets, and increased the cost of borrowing. The massive slowdown in economic output caused by the recession and the drop in household income due to the increase of unemployment reduced energy demand and consequently put pressure on oil prices. The drop in demand was quick and more pronounced in the Organization for Economic Co- operation and Development (OECD) countries. In November and December 2008, global demand growth was subdued, and 12 the November 2008 US oil demand declined by about 10 percent month on month. 1 The Organization of Petroleum Exporting Countries (OPEC) also estimated that the decline in demand for the OECD countries was around 1.3 million barrels per day, year-on-year in the first half of 2009.2 One side effect of this drop in demand was a massive increase in oil storage, pushing oil-storage facilities to their limits and leaving them with more oil than in any year since 1990 Iraq’s invasion of Kuwait. After reaching a high of $147/bbl in July 2008 driven by increasing demand for oil from emerging markets led by China and India, Brent price quickly collapsed to a low of $37/bbl in December 2008. West Texas Intermediate (WTI) oil prices had the same pattern going from $145/bbl to $35/bbl during the same period. Both Brent and WTI prices went on a long and slow recovery that started in Q1 2009. Still, they never came close to their levels before the financial crisis and only crossed the $100/bbl bar by mid-2011, driven by the uncertainty caused by the protests in the Middle East and North Africa (MENA) region in what was called the “Arab Spring”. The massive drop in prices reduced oil companies’ revenues and depressed rate of returns. The decline in revenues, 1. “Well Prepared”, The Economist Print Edition (Archived), November 06, 2008 (https://web.archive.org/web/20081109045746/http://www.economist.com/finan ce/displaystory.cfm?story_id=12564013) 2. “Monthly Oil Market Report December 2008”, OPEC, December 2008 (https://www.opec.org/opec_web/static_files_project/media/downloads/publ ications/MR122008.pdf) 13 reducing the available cash needed for investment, and the tightening credit conditions increasing the cost of borrowing, pushed oil companies to reduce capital spending and postpone projects, limiting prospects for production growth. The financial crisis caused a drop in the value of all asset types, including oil and gas companies, amid bearish market sentiments and bleak revenues projections. This further reduced oil and gas companies’ ability to use the capital markets to raise financing and attract new investors. The Organization of Petroleum Exporting Countries (OPEC) was quick to react to the deteriorating market conditions. At an extraordinary meeting held in October 2008, the organization announced its intention to reduce supply by 1.5 million barrels per day starting from November 1, 2008, to address the massive oversupply caused by the drop in demand and the strong US dollar. 3 Eventually, OPEC agreed to a further 2.5 million barrels per day reduction in supply during their December 2008 meeting.4 1.2. US shale oil boom and the supply glut The second price collapse in the 21st century was not driven by a drop in demand but rather by a massive increase in supply triggered by the development of the US shale oil.
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