ENERGEN VIEW 💡 |
International benchmark Brent closed 28$ per barrel on Friday the 17th recovering from a historic 20-year low of 15$ as it closed on the 1st of April. This is the second price crash in the last decade led by a series of social and economic events
The case of excess supply
The oil market has been experiencing periods of high volatility since the first price war in 2014-2015 where OPEC tried killing the US shale by pumping more oil into the market-a strategy that proved to be inadequate to halt the US growth. But the message was clear: The world had and has much more oil than it needs.
The demand side of things
Economic slowdown in emerging economies after 2014 also helped push the price downwards but this is reasonable as it can be attributed to economic cyclicity. In other words, the same countries that drove the oil price to 160$ per barrel in 2008 by demanding large quantities, contributed to sending the oil to trade at the 20$ levels in 2016 due to weaker economic growth.
So why is this year’s oil price crash different?
It is the second price and supply war between Saudi Arabia, Russia and the US (or at least it was prior to the OPEC ++ agreement) and a case of weak demand due to the COVID-19 pandemic.
The fundamental difference however is that back in 2014-2016 demand for oil globally was still rising at 1-2% per year, which in barrel terms is 1.8 million barrels per day. For reference, the COVID-19 pandemic has already killed 20 million barrels per day off global demand. Global energy institutions (EIA, IEA, OPEC) all agree that demand will contract or at least won’t grow year-on-year from 2019, the first time this would have happened after the 2009 Great Recession.
And the most worrying fact is that no government or global agency really knows when the effects of COVID-19 will stop or at least moderate. And even if they do, the market will still be over-supplied for some time as global storage levels are in record highs giving oil companies and traders the flexibility to sell their oil at a better price in the near term.
One can reasonably say that the industry did face the same crisis before and came through it. Through a series of cost cutting, employee lay-offs, portfolio high-grading most oil companies managed to stay afloat.
Reported project costs halved, resources that were considered expensive to produce such as US shale and deepwater projects now breakeven at 30-40$ per barrel and the industry seems to be wiser than it was before.
So why can’t the industry adapt to this new price crash come out wiser and stronger?
There is not much leverage on cutting capital costs. The oilfield services sector (EPC, drilling, maintenance services) reportedly didn’t make much-if any- profit in the past 3 years so asking them to bring down costs again doesn’t seem to be realistic at this stage. IOCs and NOCs have already reached out to their contractors asking for contract renegotiations but there isn’t much room to do so, and ADNOC has already reported 2 major-already awarded- contract cancellations and many others have reported project delays.
In 2017, more than half a million oil employees were laid-off globally both from oil companies and oil contractors. If this is replicated at the same scale this time (companies have already announced job and salary cut plans), the oil industry’s image will face a second blow. The oil industry ranks among the lowest industries in job surveys by future candidates, raising a question of talent attraction and retention.
On a first look, the NOCs look to be in a better position to weather the storm as their operational costs are 3-4 times lower than those of IOCs. But then again NOCs would face governance issues as most of them contribute greatly to their respective countries’ national budgets.
There is no silver bullet in getting out of this crisis. The OPEC++ deal on production cuts should bring the price at the 35-40$ region, but this doesn’t provide much of a safety cushion or room for profit, dividends and growth.
Maybe the COVID-19 crisis could be a wake-up call for this industry. Energy transition, digitalization and sustainability will need to go up some levels in the executive’s agendas, but these are longer term transformational goals and won’t move the needle in the near term.
Oil companies have a lot of thinking to do. From risk management to working culture, operations to strategy, all need to be revised, altered and ultimately transformed to ensure business continuity and financial commitments fulfillment.