Dynamics of Oil & Gas Industry - A New Cycle Awaits Oil Price Revival

Dr. Salman Ghouri


The world would soon bounce back from this pandemic, albeit the recovery would be rough and painful. The current regime of lower oil prices may not last forever. In fact, it may rebound due to the dynamic nature of oil and gas industry.

The exploration and production activities are mainly driven by the current and future expectations of oil prices, availability of resources and other important drivers. History informs us that higher oil prices led to phenomenal investments in upstream operations and vice versa. Going back to the recent past, persistently lower oil prices during 2014/2016 led to underinvestment in upstream and less FIDs finalized in exploration and development activities. Investments in upstream for example, plunged from $1079 billion in 2014 to $900 billion in 2015 and then further down to $583 billion in 2016. Why? Lower oil prices severely affected oil and gas companies’ revenues, cashflows, and profitability. Therefore, less resources were available for future investment in exploration and production activities.

The question is what will happen to the oil and gas industry post-COVID-19? Should we expect the regime of lower oil prices linger or the revival of oil prices? 

No doubt COVID-19 has devastated the global economies. The economic, social, and mental damage caused by COVID across the world may take years to bring us back to pre-COVID environment.

The partial and complete shut-down for months not only severely impacted the small, medium to large scale businesses but also resulted in high unemployment with many more at risk of losing jobs. For example, U.S Labor Department reported that total nonfarm payroll employment fell by 20.5 million in April, and the unemployment rate increased by 10.3 percentage points to 14.7 percent. This is the highest rate and the largest over-the-month increase since January 1948. The changes in these measures reflect the effects of the COVID-19 and efforts to contain it. Employment fell sharply in all major industry sectors, with particularly heavy job losses in leisure and hospitality.

While at a global level, the International Labor Organization (ILO), reported that some 1.6 billion workers in the informal economy, representing nearly half of the global labor force are in immediate danger of losing their livelihoods due to the COVID pandemic. Aviation industry is however, one of the worst-hit. World air traffic suffered a massive drop of more than half in March 2020, compared with the same period last year. The stories of other industries are no different, all having suffered. It is too early to determine the extent of damages that so far has occurred on the remaining industries.

The oil industry is yet another front-line sector that is severely affected. The lower oil and gas prices over the past few months not only resulted in high unemployment (the U.S. Labor Department reported that unemployment in mining, quarrying, and oil and gas extraction rose from 1.9% in January to 10.2% in April 2020.) but also significantly reduced companies’ revenues, profit, and cashflows. As such, most of major, independent as well as NOCs already incurred huge losses. For example, Occidental Petroleum Corp. reported a net loss of $2.2 billion, BP  reported $4.4-billion net loss in the 1^st quarter, ExxonMobil reported estimated first quarter loss of $610 million and also announced 30% cut in its capex for 2020 to $23 billion, compared to $33 billion earlier announced. Italian oil and gas company Eni SpA (E) reported its first-quarter net loss was 2.93 billion euros, compared to net profit of 1.09 billion euros a year ago.

While many will go out of businesses as they cannot withstand losses due to significantly lower prices – that falls below their break-even level.

A research conducted by Rystad Energy, estimated that E&P companies’ revenues are set to plunge by around $1 trillion in 2020, as compared to $2.47 trillion last year. They were also of the view that 2020 might be the year marked by the lowest project sanctioning activity since 1950s in terms of total sanctioned investments, which stands at $110 billion – only 33% compared to 2019. As such, many companies have already abandoned or deferred their major projects.

What does it all mean? It simply means that less resources are available for future investments in exploration and production (E&P) - hindering companies’ future investment’s ability. That is, subsequently inadequate resources would affect the supply side which is now in surplus.

The world in post-COVID-19 recovery phase would be needing enormous financial and energy resources to rectify the damages caused by COVID-19. During this recovery process, global oil demand slowly moves towards normalcy and may over-shoot supplies. As less resources at oil industry disposal to enhance production (at least in the short run). Furthermore, there is always a lag involved, i.e., there is no magic switch to turn on and off. It takes number of years in developing prospects, acquiring lease, seismic data acquisition & processing and drilling exploratory wells. In addition, shale oil wells that were forced to shut-down may not be able to produce the pre-shut-in level. In fact, less production but with an additional cost. COVID-19 may have also disrupted the manufacturing sites (where plants & equipment for future delivery are under construction) that might delay the project’s completion date. The list goes on and all of these surely would impact the supply side.

The world has witnessed various cycles in the past. Yet the current cycle is deep and rough as it is accompanied with COVID and excess supplies. The oil and gas industry faced with double dip dilemma. COVID on one hand, impaired global oil demand while excess supplies caused by OPEC’s strategy further exacerbated the problem – causing oil prices to plunge below $20/bbl. The time-scale of oil price recovery depends how quickly global economy revives; how fast surplus oil is consumed due to increase in demand and strict compliance of OPEC- plus to agreed production quota.

Whatever the time-scale may be, a new cycle awaits and the world would soon witness increasing trends in oil prices till a new equilibrium is restored, albeit at a higher price.

Three Scenarios That Could Push Oil Back Above $30

Dr. Salman Ghouri

Asia is home to 60 percent of the global population and is the largest consumer of total primary energy, oil, coal, and renewables. It is also the third-largest natural gas consumer behind Europe and North America. As more natural gas becomes available in the form of LNG and piped gas, the region will soon become the world’s largest consumer of natural gas as well. Despite being the world's largest consumer of oil, the Asia Pacific region only holds 2.8 percent of global oil reserves and only produces 7.63 million barrels per day (mmbd) compared to its oil consumption of 35.8 mmbd. That is an enormous amount of oil it has to import on a daily basis.

Asia’s High Oil Import Dependency and the Strait of Hormuz

In 2018, over 78 percent of Asia-Pacific oil demand - 28.17 mmbd - was imported. Of those imports 20.7 mmbd, or over 73 percent of regional oil demand, transited through the Strait of Hormuz - a very narrow ally connecting the Persian Gulf with the Arabian Sea and a critical route for global energy security and international trade (Figure-1). This small ally is about 21 miles wide at its narrowest point and due to depth restrictions is only about two miles wide in each direction for tankers. This supply chain is the backbone of Asia’s economic prosperity - China, Japan, India, South Korea, Singapore and Taiwan are just a few of the countries that rely heavily on this strait. It is also the major supply route for oil and gas exports to Asia from the Gulf. Any disruption in the Strait of Hormuz, a major chokepoint for oil and trade, can lead to substantial supply delays would shift market sentiment dramatically. While there are alternative routes, they are significantly longer and more expensive. A disruption in this area could also expose oil tankers to theft from pirates, terrorist attacks, political unrest (in the form of wars or hostilities), and shipping accidents that can lead to oil spills.

Figure-1: Crude oil, condensate and petroleum products transported through Strait of Hormuz. Source EIA

Three scenarios that could send oil prices higher

Out of the many possible scenarios that market observers must consider, the three listed below are the most likely to send oil prices higher. The first is based on market fundamentals, the second on natural disaster, and the third on human intervention.

Market fundamentals

It is now obvious that global oil demand is significantly lower than supply. Even the OPEC+ agreement to cut 10 mmbd wasn’t enough to balance markets. As long as supply remains significantly higher than demand, prices will remain in the twenties or even lower. In order to bring the market back into equilibrium – oil production has to fall substantially, or demand must begin to bounce back. If OPEC+ and other non-OPEC actors including US shale oil producers decide to cut oil production in the range of 20-25 mmbd for a couple of months or until the surplus is exhausted, then oil prices should recover. These sweeping production cuts would be good for the entire oil industry. A cut of this size would see prices move back into the $30 to $50/bbl range in a relatively short period of time.

If, however, other oil producers are hesitant to take part in a second OPEC+ cut, we will likely see the cartel remain with its existing strategy of a 10 mmbd production cut. The world will continue to experience a surplus of oil supply and low prices will persist until the market finds its new equilibrium. As global storage reaches capacity we will see unplanned shut-downs which will hurt the oil industry at large and shale producers in particular. Many smaller producers will be forced to shut down temporarily while others will go out of business. Oil prices will remain low for an extended period of time as the world waits for global oil demand to return and the impact of the COVID-19 pandemic to fade.

Natural disaster

The second possible scenario is that COVID-19 hits the supply chain directly – namely at an oil production site or refinery – partially halting production and refining operations. This kind of dramatic event would instantly increase oil prices into the thirties. If this outbreak persists for weeks, it will eventually send oil prices to over $40/bbl irrespective of surplus. Nevertheless, such an increase will only be short-lived as demand would remain depressed and eventually production would come back online.

Human intervention

Back in September 2019, Saudi Aramco oil facilities were attacked – disrupting a significant amount of oil. These attacks led to relatively large daily price change and lots of intra-day trading volatility. In light of this attack and many similar ones in the past, the third possible scenario is human intervention. If Iran overreacts to recent tension in the Gulf and closes the Strait of Hormuz to hurt Gulf oil exporters, for example, the impact on the oil market would be very noticeable. Iran is unlikely to escalate tensions to the point where it closes of the Strait of Hormuz as it would severely damages its own economy with such a move. In the extreme scenario that this does happen however, it will be considered a direct challenge to the U.S. This may lead to further escalation in the Gulf and could even lead to a proxy conflict. In this scenario, oil prices would bounce back above the thirties and could even reach above $50 per barrel.

All three of the above scenarios will lead to an increase in oil prices as the market is forced to quickly adapt to a new supply-demand dynamic. The time scale of each scenario varies depending first upon the sentimental impact and then upon how quickly it can bring global supply back into balance with demand. Scenarios 2 and 3 will be short-lived as they fail to solve the fundamental problem of a surplus in supply. The option of a coordinated effort between all oil producers appears to be the optimum solution for those looking to increase oil prices to $30 and beyond. Such coordinated efforts would also save the oil industry from further demolition.

By Salman Ghouri for Oilprice.com - published on April 27, 2020
https://oilprice.com/Energy/Energy-General/Three-Scenarios-That-Could-Push-Oil-Back-Above-30.html

Post COVID – A Difficult and Painful Journey Ahead!

Dr. Salman Ghouri

The year 2020, started with different kind of challenges. Challenges that most of us have never experienced in our life. The invisible enemy that spread the havoc around the world – sparing no one irrespective of religion, caste, where you live - it globally. As of April 29, more than 3.2 million people have been infected and over 220 thousand deaths across the globe have occurred. Though in Europe and some other countries, there has been a decline in recording of new cases and deaths as well. While for others, it is just the beginning particularly in Asian and African countries where covid started spreading late.

Despite the world being geared up with the latest state-of-the-art technology, thousands of nukes, supersonic aircrafts, missiles, chemical weapons etc. Yet all of those are worthless against invisible enemy. A tiny virus that is hard to detect under powerful microscope had a havoc and did not spare any nation – forcing most of the countries to partial or be on a complete lock-down for months. The hardest hit has been in Europe and North America. Initially majority of nations did not take this pandemic seriously. Even though after over 3.2 million effected and 220 thousand deaths, some are still thinking that it is nothing but a conspiracy! 

The world is helpless as thousands of people are dying every day around the world. In the absence of vaccine, different medications have been tested – like chloroquine and antibiotics. In some patients it has worked but generally in most it has not. The only way to deal with this havoc is to lockdown the cities entirely – leading to social distancing until a development of vaccine. This has helped to improve the spread of virus but at the economic cost that now is estimated to be well into tens of trillions of dollars.

The rapid spreading of COVID-19 around the world led to global recession as well as plunging oil demand – as fewer cars are on the road, only handful of flights taking off, partial or full shut-down of factories/industries. The world is at a stand-still. It has affected the livelihood of small to large scale business such as: restaurants, aviation, hotels and tourism industries, doctors’ private clinics, retail shops, daily wage earners, and the list goes on.

According to the International Labor Organization (ILO), some 1.6 billion workers in the informal economy, representing nearly half of the global labor force, are in immediate danger of losing their livelihoods due to the covid pandemic. Aviation industry however, is one the worst-hit. World air traffic suffered a massive drop of more than half in March 2020, compared with the same period last year. The stories of other industries are no different, all having suffered. It is too early to determine the extent of damages so far occurred.

The question is what will happen if one fine morning we get up and find ourselves in a world of COVID free environment.  

The physical, mental, economic and financial distress created by this short episode may remain with us for many years. The world would be needing tens of trillions of dollars to clean up this mess and bring back all the industries, including all other directly and indirectly associated business to pre-COVID environment. The economic and financial destruction caused by COVID in few months, may requires years to repair. Yet physical and mental agony may require countless years. The recovery from the aftermaths of COVID would not be possible without each other support. It is not that simple. It may require financial support of donor agencies (IMF, the World Bank, IBRD, ADB, IDB etc) in the form of write-offs, debt relief and further financial assistance, particularly the developing countries. Moreover, developed countries support is also needed in painful journey of recovery.

Due to the lockdown global oil demand far exceeded its supplies, which was further exacerbated by OPEC strategy of over production. In this painful journey of lower oil prices many US shale oil producers and small producers are forced to shut down while many will go out of business.  As the world storage nearing capacity oil prices slipped down hill and once declined to negative $37.63/bbl May contract.   

The world is in catch-22 situation. On one hand, if oil prices remain softer – post COVID, it will be a blessing for the global economic recovery from the aftershocks of COVID. Savings out of reduced oil import bill would be spent to fix the devastation caused by COVID that requires significant amount of resources.

While on the other hand, lower oil prices over extended period of time has already severely affected the oil industry. The lower oil and gas prices with global weak oil and gas demand has significantly reduced companies’ revenues, profit, cashflows, which would be poorly reflected on companies’ profit & loss and balance sheet. 

They already incurred huge losses and therefore less resources are available for future investments in exploration and production (E&P). A research conducted by Rystad Energy, estimated that E&P companies’ revenues are set to plunge by around $1 trillion in 2020, as compared to $2.47 trillion last year. They were also of the view that 2020 might be the year marked by the lowest project sanctioning activity since 1950s in terms of total sanctioned investments, which stands at $110 billion – only 33% compared to 2019. Many companies have already abandoned or deferred their major projects as well as reduced dividend payments. Shell, for example, is among the first major oil and gas company slashing its dividend by 66%, from $0.47 to $0.16 per ordinary and B ordinary share. On May 1, 2020, ExxonMobil reported estimated first quarter loss of $610 million and also announced 30% cut in its capex for 2020 to $23 billion, compared to $33 billion earlier announced.  While other companies to follow soon.

What does all this mean? Subsequently, inadequate resources would affect the supply side which is now in surplus.

If this happens, dynamics of natural cycle would be repeated – mismatch in demand/supply. During this cycle, oil demand in the post-covid recovery period will exceed supplies. As less resources at oil industry disposal to enhance production (at least in the short run). The world would soon witness increasing trends in oil prices till new equilibrium is restored, albeit at a higher price. The world has witnessed various cycles in the past. Yet the current cycle is more deep and painful as it is accompanied with invisible enemy (covid) that impaired oil demand while sitting on the lap of excess oil supplies.