A New Oil & Gas Order in The Making?

A New Oil & Gas Order in The Making?

With the emergence of the coronavirus pandemic and an unprecedented price war, 2020 should go down in history as a defining moment for the oil and gas industry.
Four months after the looming of the pandemic, the US West Texas Intermediate (WTI) crude fell to an unbelievable negative $37.63 a barrel while Brent crude sank below $16 a barrel, its lowest level since the beginning of the century, as storage facilities all over the world were overwhelmed by stockpiles.

The low prices were no wonder as oil producers have continued to pump record levels of crude even as the outbreak pushed oil demand to its lowest levels since 1995.

The crisis has wiped billions from the market value of oil companies, many of which will not be able to pay dividends if the crisis stayed for a longer period.

Even a historic pact to cut production by 10 million to 20 million barrels of oil seemed too little and too late to avoid a market crash.

Fatih Birol, head of the International Energy Agency (IEA), described 2020 as the worst for the oil industry, as his agency estimates that global oil demand this year will fall by 9.3 million barrels per day (mmbbl/d) versus 2019,erasing almost a decade of growth- even if restrictions are eased in H2 2020.

The coronavirus has devastated the world economy. However, for the oil sector, the matter was even more complicated by political conflicts that haunted the sector over its history.

Counteracting a Crisis

Lockdowns imposed by governments all over the world to contain the pandemic have resulted in a sharp fall of nearly 30% in oil demand as airlines have cut services, factories closed  doors, and drivers deserted the roads.

China’s total refinery output, for example, slumped by around 3.3 million barrels per day (mmbbl/d) in February from the month before to just over 10 mmbbl/d, according to S&P Global Platts survey. This is close to a 25% month-on-month decline.

Due to the pandemic effects, the Organization of the Petroleum Exporting Countries (OPEC) had to amend its prospects for oil demand in 2020, saying that global oil demand will drop by 6.8 mmbbl/d in 2020, with the sharpest contraction in April.

Politics Is the Root of All Evil

At the beginning of the crisis, Saudi Arabia, the second largest oil exporter that possesses around 18% of the world’s proven petroleum reserves, tended to practice its usual role as the influential OPEC member who is able to control prices and dictate cuts. However, the Saudi move to contain the situation by proposing production cuts was refused by Russia, the influential oil producer, who saw the low oil prices as a good tool to harm the US shale oil industry.

As a counterattack forRussia refusing to support OPEC+ output cuts, Saudi Arabia had pumped every possible barrel for sale at rock-bottom prices.

The price war, that lasted for nearly sixweeks, forced oil companies to slash spending and cancel investments, while oil-rich countries appealed to the International Monetary Fundfor help.

After strong pressure from US President Donald Trump, Saudi Arabia and Russia ended the devastating price war, agreeing to slash output together with other members of the OPEC+ alliance.

Despite of the historic agreement between OPEC and its partners to cut output by almost 10 mmbl/d from May, prices remained at multi-year lows as demand needed to pick up again.

Members of OPEC and their allies, including Russia and Mexico, announced in mid-April that they have agreed to cut production by 9.7 mmbl/d in May and June, the deepest cut ever agreed to by the world’s oil producers. After that, the group will steadily ramp up production until the agreement expires in April 2022.

According to IEA, “the historic decisions taken by OPEC+ and the G-20 should help bring the oil industry back from the brink of an even more serious situation than it currently faces.”

According to analysts, situation would have been far better for the oil industry, if the initial production cut proposals were taken seriously. It seems that parties of the price war underestimated the effects of coronavirus on the global demand.

Although effects of political conflicts are not new for the oil sector, the recent conflict seems to have more devastating impact, not only on the oil industry, but also on the political regimes that took part in this conflict.

A War with No Winner

In Saudi Arabia, where the energy sector, according to a Bloomberg report, accounts for about 80% of the kingdom’s exports and two-thirds of its fiscal revenue, the decline in oil is expected to hinder Crown Prince Mohammed bin Salman’s efforts to diversify Saudi Arabia’s economy away from oil — a campaign that was mainly funded by oil revenues.

The kingdom had to cut expenditures by $13.2 billion, or nearly 5% of its budget spending for 2020.

The price war also cast shadow over the historic Saudi Aramco’s initial public offering (IPO) of last year as many investors now show concern over the political risk associated with the company that Saudi Arabia still uses as a political tool.

While Saudi Arabia’s price war was against Russia, it had its damaging repercussions for nations whose economies depend on oil exports, such as Venezuela and Iran. It also devastated emerging economies such as Brazil, Angola and Nigeria.

The outcome of the price war was not in favor of Russia either as Russian President Vladimir Putin had to postpone several social spending programs that he had hoped would stimulate a stagnant economy.

Under the new agreement, Russia will cut production four times larger than the proposed cuts in March. Russia has not only lost revenues from weeks of lower oil prices, but also undermined trust in its judgement and opened the door for US to play a key role in brokering the new OPEC+ agreement.

But one of the bigger losers in the war until now seemed to be the US oil companies, many of which now face the danger of bankruptcy.

Trump, who cheered the OPEC+ agreement, had to come out with what he described as a plan to prevent the looming wave of bankruptcies and mass layoffs in America’s oil industry after US oil prices crashed into negative territory for the first time ever. However, no details were announced about this plan.

Not in Anyone’s Interest

Some people may cheer the low oil prices as a good opportunity for growth in poorer countries who are likely to increase their spending on other goods and services. It also may help economies recover more quickly and help prevent a recession becoming a depression.

However, very low prices will be negative for all as the larger the fall in the oil price, the bigger the risk that the negatives outweigh the positives as risk of deeper recessions for producers is growing and many oil companies may be driven out of business altogether.

Very low prices may be also bad news for savers and pensioners as the world’s biggest oil and gas firms may consider cutting dividends as they weather the fallout from the pandemic.

Manyoil companies’ cash goes directly into pension schemes. BP and Shell contribute nearly a fifth of all dividend income generated by UK companies for example. Public coffers also may suffer big loses of taxes payed by these companies.

Whiting Petroleum Corp became the first major shale producer to file for Chapter 11 bankruptcy.

Some of major companies had to cut their expenses and investments such as Exxon Mobil Corp., which cut its capital budget for 2020 by 30%, or $10 billion, while a company such as Baker Hughes said it approved a plan to slash its 2020 net capital expenditures by more than 20%.

And then there are the environmental concerns as cheap oil will limit economic incentive to look for renewable and clean energy sources.

The current prices crisis may also threaten stability in several countries which mainly depend on oil exports.

Although such low prices can help Egypt in decreasing the burden on public budget, the country’s oil sector will be negatively affected by plans of international oil companies (IOCs) to cut their exploration and production (E&P)investments in different countries including Egypt.

As confirmed coronavirus cases surge around the world, uncertainty also grows about what is next for the oil and gas industry. Until scientists find a solution for the disease that haunted the world, it is the role of politicians to put their differences aside and formulate a way to shore up this important industry.

It became clear that the drop in oil prices due to OPEC’s loss of pricing power is a sign that a new oil and gas order is in the making. Hence, oil companies should be prepared for the uncertainties, risks, and opportunities ahead.


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