The confinement of billions of people during the Covid-19 crisis is modifying not only our habits but also our energy consumption, notably in the transport sector, which relies for close to 100% on oil and oil products.
As a consequence, oil prices are falling to levels not seen since the Asian crisis in 1998. On 20 April, the price of West Texas Intermediate (WTI, the USA benchmark for crude) plummeted, hitting a historic low. The price of WTI crude then further plunged into negative territory, creating a situation in which some producers are ready to pay in order to sell their products. This paradox happens when the price of storage of a products is higher than its market value.
Looking at past behaviour of energy and oil markets could provide an instrument to better understanding current trends in both oil price and demand.
Looking at the past to understand the present
Historic recurrence is the repetition of similar events in history, such as the rises and falls of empires. Could historic recurrence be applied to the oil industry, which is by the way a cyclical business?
Between 1979 and 1983, for example, OECD countries implemented policies of energy efficiency and fuel switching, which constrained the oil demand by 6 million barrels of oil per day (mb/d). Moreover, in that period, non-OPEC countries brought 6 mb/d of oil on stream from the North Sea, Alaska and Mexico. All in all, the global demand of oil from OPEC decreased by 12 mb/d.
The result of such demand disruption and increased oil supply impacted heavily the oil price which tumbled from a 40 USD band in 1980 to less than 10 USD in 1986.
Estimates for the current oil demand disruption increase every day. The International Energy Agency in its latest Monthly Oil Report indicates a reduction of 29 mb/d in April 2020, in comparison with the same month in 2019. The overall reduction in 2020 versus 2019 was estimated at 9.3 mb/d, which assumed a certain normalisation of demand in the second half of 2020.
There are analogies between the current reduction of oil demand and what happened in the 1980s. A that time, oil demand was seriously hit, and it took a decade for oil consumption to go back to the level of 1980. Oil prices were reduced four-fold and went back to the 40 USD band 20 years later.
Which lessons can we learn from past?
Even if OPEC+ implements the 9.7 mb/d cuts agreed at their meeting on 9 April 2020, the world will still be flooded with oil, as it was in the late 1980s.
Therefore, in the short term, unless additional substantial reductions of supply are implemented, the oil price is going to tumble as it did in previous oil countershocks. The Brent price of 26 USD (of 20 April 2020) seems unjustified on the ground of the current supply and demand balance.
In the medium term, the humankind will defeat Covid-19 as we defeated other diseases such as the Spanish flue. The equation which will determine the duration and the magnitude of the Covid-19 crisis has many unknown factors but, at a certain time, we will win the disease.
However, at such time the oil demand, will not start running. The oil demand will barely “start walking” and in a post-Covid scenario, there will be a structural reduction of our oil needs.
On 14 April, the International Monetary Fund (IMF), estimated that global gross domestic product will shrink 3% this year. The IMF foresees an optimistic economic growth of 5.8% in 2021 but, other analysts are more conservative and see a U-shaped recovery, rather than the V shaped recovery predicted by IMF.
After the pandemic, GDP will struggle to grow and, consequently, consumers will have less money to spend and in particular less money to spend on oil consuming activities such as travelling and commuting.
Moreover, there will be permanent changes in our transport habits, which will continue beyond the confinement measures of today. Similar transport constraints happened in the past, for example difficulties in travelling during a strike of public transport and, in some cases, such constraints induced permanent changes in transport modes.
In March, The Economist published a seminal article, illustrating analogies between the current lockdown and a strike of the London underground in 2014. To cope with the strike, travellers conceived different ways of commuting but, when the strike was over, 5% of them realised that they had discovered a more efficient way to travel to their work.
The same will happen in a post Covid-19 scenario. In such scenario there will be, inter alia, a more widespread use of teleworking. In the past months, people and companies have realised that in several cases it is not necessary to go the office every day.
The discovery of the efficiency of teleworking could induce structural and far reaching modifications to our working model. Workers, particularly commuters, could save time and money by being able to work from home. Employers would question if their employees need to come to the company premises every day and would think if they need to provide them with offices which would be used less than 40 hours in a week.
Companies and shareholders would reconsider the need to move CEOs and legions of executives around the globe in expensive and polluting intercontinental flights. Political leaders could also realise that it is not compulsory to move regularly across the world in private jets packed with an army of bodyguards and political attachés. A videoconference could make it and all these VIPs would be able to spend their evenings with their families.
Videoconferencing is the new mantra; our children hold daily teleconferences with their friends and teachers. If they do it, why should adults not be able to do the same at least in 10-20% of their meetings.
The oil market developments in 2020 resemble a faster version of events in the early 1980s.
In the 1980s oil demand fell by 6 mb/d and oil price decreased four-fold. It took 10 years for oil demand to return to pre-shock levels and two decades for oil prices to go back to a 40 USD level. In my view, in the short-term, oil prices will be seriously cut.
In the medium term, in a post-Covid world, there will be a permanent reduction of oil demand.
The World Energy Outlook of the International Energy Agency published in November 2019 (in a pre-Covid world) indicated that oil would reach its peak demand in the mid-2020s. I believe that, at the end of 2019, we had already reached peak oil demand. In the future, oil consumption will not go back to the 100 mb/d that we used in 2019 as our working and transport habits will change permanently. The Covid-19 revolution will therefore completely reshape the energy arena.
Any decision maker in an oil producing country/company should ask his or her economic team to model and quantify the impact of the pandemic.
There will be winners and losers and in a Darwinian selection only the smartest and the fastest will survive. Countries and companies with the highest oil production cost will have to leave part of their oil reserves stranded underground. There will be mergers, acquisitions and unfortunately many bankruptcies.
To conclude on an optimistic tone, there will also be positive consequences. If we reduce travel in road and air transports, we will not only decrease oil consumption but we will also reduce emissions in some of the sectors for which decarbonisation is more difficult. This will have positive effect in our battle against climate change and will help us in reaching climate neutrality.