By: Paul Carthy, Managing Director – Energy Industry Group, Accenture in the Middle East
The oil and gas (O&G) industry is no stranger to supply and demand shocks and has weathered more than a dozen such jolts over the past four decades.
In the run-up to the COVID-19 pandemic, the oil and gas industry was already amid considerable disruption. Sector returns were under pressure, the capital was flowing away from the industry, and decarbonization headwinds were strengthening to capital increases. Most of the supply-side shocks, excluding 2014’s bump, were the result of sudden supply pullbacks as a reaction to geopolitical unrest. On average, the impact of these market-tightening tremors lasted anywhere between one and six months. Fluctuating demand was primarily due to macroeconomic contraction and was closely connected to more astronomical volatile economic cycles - in terms of size and duration.
However, despite the turbulences the industry has endured over the years, two uncharted global events took set to shape a new and perhaps, even more, disruptive market:
- COVID-19 is driving a demand-side shock that is expected to result in approximately 3-5 million bpd through to end-2020. Global oil demand is expected to be lower in 2020 compared to 2019, which has not been the case in more than a decade.
- A concurrent supply-side shock is emerging from OPEC+ and Saudi Arabia’s plan to open the floodgates on oil supply precisely as the economy prepares for a contraction.
The confluence of these two shocks creates an unprecedented situation and is, therefore, difficult to anticipate. However, if we piece together the various elements of supply and demand in light of these events, it appears that their impact could last well into 2021, with a disproportionate influence on US oil production. Overall, it is likely that we are in for a turbulent 2020, and a lukewarm 2021 in which commodity markets will be under considerable pressure. Given the imminent worldwide recession, it’s hard to see any winners in this scenario, with producer nations, investors, O&G companies, and green/new energy businesses all set to lose.
Simultaneous demand contraction and a concurrent ramp-up in supply are unprecedented. We are in uncharted waters, and it isn’t clear who will win this game of brinkmanship. In this context, we can expect current low prices to prevail and quite possibly drop even further if OPEC+ continues to pursue the flood-the-market approach. This will destroy demand and result in oversupply.
Furthermore, in this scenario, resources became more abundant, the market more competitive, and alternative energy sources more prevalent, lowering the bar for alternatives to specific sources of O&G supply. The downstream sector that served as a cushion in 2014/15 for the industry at large, and specifically, for pure-play refiners and international oil companies (IOCs) as a result of improved margins, cannot be a savior in this cycle. The potential for higher margins will be blunted by reduced volumes as a result of the economic contraction that is set to occur.
As for natural gas, the onset of a global recession will affect demand, though not as much as for oil. However, supply adjustment will be limited, and even associated gas reduction is set to take time, resulting in the continued risk of lower prices. Regardless, this price risk will be more subdued than oil as the gas market was already fending off a market glut before the pandemic hit.
Still, once the global economy stabilises and growth returns, we need oil and gas to sustain development and drive prosperity in the developing world, and to meet the needs of more than two billion people, who will join the global population.
Also, while the logistics involved in oil and gas extraction have improved considerably since the last supply shock in 2014 - by up to US$10-US$20 per barrel – ultimately, the full-cycle breakeven economics of the marginal barrel will set the equilibrium price. And, that breakeven price is still in the high US$50s to low US$60s per barrel. Markets can stay irrational temporarily, but in the long run, fundamentals will prevail.
Challenging times call for intelligent measures - both traditional and non-traditional. The industry has pulled itself out of many shocks and proven skeptics wrong in the past (think peak oil that preceded the 2014 supply renaissance and disruption). However, it is now faced with concurrent disruption at an existential, system-wide, and best-in-class player level – these are risks that will truly test its tenacity and durability. While little can be done to counter the inevitable, making difficult but informed decisions and following a strategic roadmap will help oil companies to endure the downturn and anticipate the next peak.