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Big oil – Staring down the barrel of an uncertain future

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Mark LEWIS
 

After three months of convulsions, the global oil industry appears to be stuck between a rock and a hard place when contemplating its future. Oil majors need to decide how best to tackle the factors that are raising an increasingly large question mark over their business model, explains Mark Lewis, Global Head of Sustainability Research at BNP Paribas Asset Management, in a new briefing paper.

  • Recent oil price volatility may just be a foretaste of what is to come
  • Fallout from the pandemic may mean 2019 was the year of peak oil demand
  • The 3 D’s putting on the squeeze: decarbonisation, deflation and detoxification

Let’s start with the ructions

Three months is a long time in (oil) markets. In late February, oil industry analysts and investors were watching the struggle over the appropriate response to an increasingly oversupplied market closely. The glut came to the fore as the COVID-19 pandemic cut into oil demand in China, the world’s second largest consumer and the single biggest source of global demand growth.

In early March, tensions boiled over when Russia refused to cooperate with other members of the OPEC+ group of oil producers in a renewed round of output cuts. This prompted Saudi Arabia to raise supply and slash its export prices to try to re-establish its hegemony as the world’s largest oil producer.

The market reacted swiftly and violently: crude oil prices dropped by more than 30% on 9 March. By then, the pandemic had spread to Europe and North America. As lockdowns took hold almost worldwide over the following weeks, analysts and investors switched their focus to the demand side, namely the unprecedented drop in oil consumption.

The price volatility of recent months may just be a foretaste of the drama to come as the end of the petroleum age comes into view. In turn, this means investors are likely to find the visibility offered by the business model of renewable energy companies all the more attractive compared with the volatility inherent in the business model of the oil majors.

The pandemic brings the prospect of peak demand closer 

Already under increasing pressure from long-term structural changes in world energy markets, the oil industry suffered its biggest ever drop in demand in the last two months.

Indeed, it seems reasonable to ask whether demand peaked already in 2019. After all, the structural pressures on global oil demand will still be there when the lockdowns are eased. However, the behavioural changes prompted by the pandemic will now compound their force. These may well endure.

On the structural side, the industry now finds itself in the squeeze of the three “D’s”: decarbonisation, deflation and detoxification.

Decarbonisation. To stand any chance of achieving the goal of the Paris Agreement on climate change, we have to decarbonise transport and industry as quickly as possible. That means burning less oil.

Deflation refers to the impact of renewable energy. The cost of renewable energy has plummeted over the last decade thanks to technological improvements and economies of scale.

According to a recent IEA study of the impact of the pandemic on energy markets, renewables will be the only form of energy to see demand growth in 2020. With more than 50% of global oil demand accounted for by road transportation, the electrification of mobility made possible by the rise of electric vehicles poses an existential threat to the oil industry, as we argued in this in-depth report.

Third, there is the pressure to detoxify the air in cities. This issue was already rising up the global policy agenda before the virus struck, but with lockdowns resulting in blue skies and cleaner air, citizens will likely now push harder for a faster phase-out of petrol and diesel vehicles in the largest conurbations.

Another squeeze: behavioural changes

The pandemic-driven increase in working from home has eliminated hundreds of millions of daily commutes. This may give rise to permanently higher rates of teleworking in future.[1] The oil demand lost in the lockdown may well never return.

International air travel – one of the fastest growing sources of oil demand over the last two decades – has evaporated due to the lockdowns. And with businesses reaping cost savings from substituting videoconferences for face-to-face meetings, many may now think twice when it comes to approving future long-haul trips. Some air travel may therefore have disappeared permanently.

Some oil demand associated with large-scale leisure activities may also be lost for good. Until a vaccine is found, some level of social distancing will likely continue to militate against easing the restrictions on large gatherings rapidly. Sporting events and many other forms of collective leisure and entertainment may be on hold for a while yet.

Conclusion: Renewables versus oil: visibility versus volatility

In short, the future for oil is now more uncertain than ever before. Against this backdrop, the pandemic will likely accelerate the energy transition[2] away from fossil fuels and towards cleaner renewables.

Depressed returns and volatility in oil markets will likely to weigh on investor sentiment for the foreseeable future, thereby boosting the attractiveness of renewable energy projects offering lower-risk, longer-term visibility on the earnings of oil majors.


Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

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