Assessments of Future Oil Markets and Current Investments in the Oil and Gas Sectors

EPC | 10 May 2020

Oil markets have experienced their biggest crisis in the modern age. The negative dimensions of the coronavirus crisis and the price war crisis between Saudi Arabia and Russia have greatly affected the oil sector in terms of prices and existing and future investments. Those crises have brought the sector to a standstill. On the one hand, the shock has been unprecedented for the global energy markets in terms of both the speed of its spread and the size of its impact. On the other hand, the spread of coronavirus has led to the collapse of global demand for liquefied natural gas (LNG) and disrupted industrial production.

With regard to investments in the oil sector, one of the main effects of the oil supply crisis today is the announcement by major companies in the oil sector of reducing capital expenditures, particularly in the area of exploration and development of new oilfields. Low oil prices will be translated into higher oil prices in the future if investments in drilling, exploration and production are halted.

This paper aims to assess the current situation and investments in the oil and gas sectors and predict the future scenarios that can face the oil sector after the heavy blows it received during the past period. It poses the questions: what could this major shock in the energy markets mean for the future of the fossil fuel industry? and could it amount to the end of continuous reliance on oil?

Limits of the effects of the current crisis on existing oil investments

The degree of the effects of the current crisis on existing oil investments can be explained through the following:

a. Reduction of capital expenditures: major oil companies have reduced their capital costs by up to 20 percent. The Italian company Eni plans to cut its capital spending by 30 percent and call off the re-purchase of shares worth 400 million euros as a result of the postponement of exploration, production and development projects in Egypt, the UAE and Indonesia, in addition to oilfields in Iraq and LNG projects in Angola. As for the shale oil sector, energy experts expect a 40 percent reduction in expenditures by the end of 2020. Global capital expenditure by exploration and production companies in 2020 is expected to decline by nearly 32 percent, its lowest level for 13 years. On the other hand, a large number of state-owned energy companies in the region have had to reduce their expenditures and postpone many of their investment projects in 2020, such as Algerian Sonatrach which has decided to reduce investment expenditures for the current year by nearly half to 7 billion dollars. This reduction in financial resources also undermines the capability of the oil sector to develop some techniques necessary to shift to clean energy throughout the world. The impact of the reduction of capital expenditures will reflect on supply restrictions for a long time to come. Over time, this creates the potential of a price recovery in the future after overcoming the current crisis. This can also create an incentive for another wave of investments to expand the capabilities of the global oil industry, as was the case with the recent leap in the US shale oil industry.[1]

b. Production cuts: some companies have tended to cut their production in some oilfields. ConocoPhilips has confirmed that it will cut its North America production by 225 thousand barrels per day, the largest cut so far by a major producer of shale oil, to accommodate the unprecedented decline in demand. The re-activation of idle wells takes a long time and entails a high cost. The Brazilian national oil company Petrobras has announced a production cut of 100 thousand barrels per day for the rest of 2020. It will mothball the operation of some shallow-water platforms due to high production costs. While two thirds of the world’s oil production platforms may have to shut down, a Goldman Sachs report has predicted that nearly 20 percent of global production will be slashed within three to four weeks.[2]

c. Postponement of work at some projects and shutdown of some oilfields: US company Continental Resources has suddenly announced that it is shutting down some oilfields in the states of Oklahoma and North Dakota and that it is unable to deliver crude shipments to clients due to poor economic feasibility. British Sound Energy, the licence holder of the Tendrara gas field in eastern Morocco, has postponed signing final exploration and production contracts with the Moroccan government till the end of June 2020.[3]

d. Sharp fall in the profits of energy companies: British Petroleum (BP) has announced a decline in its profits by two thirds in the first quarter of 2020 due to the implications of the price war and the impact of coronavirus on undermining oil demand. The Norwegian oil giant Equinor has also cut its quarterly dividends by two thirds.

e. Plans to save oil companies: Many countries that own a large portion of oil investment companies in the world have been quick to study offering support to those companies to support the continuation of their oil activity. US Treasury Secretary has confirmed that the government is studying acquiring shares in US energy companies as a potential option as part of its efforts to help the country’s oil and gas sector.[4]

f. Impact on existing labour force in different projects: most exploration and production companies and oilfield service providers had to encourage a large number of their workers to stay at home and refrain from travelling abroad. For instance, Royal Dutch Shell was one of the first companies to suspend travel abroad by its staff and managers. US company Chevron has asked its staff to postpone travel and has even asked its London staff to return to the US.[5]

g. Negative impact on supply chains: the supply chains of the oil industry, including refineries and petrol stations, will be affected. Refineries are likely to adapt to the fall in fuel consumption in local markets through the reduction of their production capacity.[6] In their turn, many petrol stations may have to reduce their operations. For instance, sales of oil derivatives have clearly stopped in Iran in view of the spread of coronavirus and movement restrictions. This would drive to shutting down 70 percent of the petrol stations all over the country.[7]

Limits of the effects of the current crisis on investments in the gas sector

The extent of the effects of the current crisis on those investments can be explained as follows:

a. Decline in prices as a result of decline in demand: demand for gas in Europe will be nearly 5 percent below the pre-epidemic expectations if the lockdown continues for limiting the virus spread. In addition, commercial demand for natural gas has declined due to the lockdowns experienced by many countries as a result of the epidemic. Figure 1 shows the decline in demand for natural gas in Europe, one of the most important gas consumption markets.

b. Postponement of some promising gas projects: especially in areas with large gas reserves. The Lebanese Ministry of Energy and Water has decided to extend the deadline for submitting applications for the second offshore licensing round to explore oil and gas in Lebanese waters in the Mediterranean till June 2020 instead of April 2020. Italian company Eni plans to cut spending on its projects in Egypt after having recorded a decline in profits of the first quarter of 2020 by 94 percent to 59 million euros compared to 992 million euros in the same period a year earlier due to the decline in demand for oil and gas as a result of coronavirus. On its part, the Egyptian Ministry of Petroleum has confirmed that an agreement between companies owned by the Egyptian government and Italian Eni and Spanish Naturgy companies for re-activating the Dumyat liquefaction plant has been cancelled due to the implications of the spread of coronavirus.

c. High costs of gas exported to Asian countries compared to European countries that are much more flexible in prices due to low logistical costs[8] and large storage capacities. Europe boasts a storage capacity of nearly 100 billion cubic metres which allows for greater flexibility to accept volumes compared to the more storage-restrained Asian countries.[9]

Size of the flexibility and strength of main markets in the oil sector   

a. Production markets

The degree of flexibility and strength of those markets varies as follows:

  • The world produces 100 million barrels per day. Of these, 71 million barrels are consumed daily while the rest are stored. Considering that the storage capacity is limited, that some producers are unable to stop production because of the enormous restart costs, and that the pumping rates in some oilfields, such as those in Russia,[10] cannot be adjusted, the markets will be greatly affected by the crisis, particularly in view of the decline in oil demand, which increases further the price downward trend.[11]
  • Traditional production markets (such as Saudi Arabia and Russia) are characterized by a high degree of flexibility towards market and price fluctuations thanks to low production cost. However, the main obstacle limiting this flexibility is the need by those markets of oil prices at specific limits (sometimes up to 80 dollars) due to reliance by the budgets of those countries on oil prices as their main source.
  • The degree of sensitivity of shale oil and high-cost oil markets to market fluctuations is quite high due to high production cost. This means that a specific price is required for the viability of the industry in general. This makes the traditional oil markets capable of driving high-cost oil producers from the market at any time in case traditional oil producers can afford low prices. However, shale oil is capable of returning to operation in case prices recover together with the continuous development of production technology to reduce cost.
  • Markets with onshore oilfields that are far from shipping and storage tankers are considered to be the ones that will be most affected by the crisis in view of the decline in prices, increase in storage costs and difficulty of access to the production of those wells or dealing with production in view of the current crisis.[12]
  • The cost of the barrel of oil increased even for countries that were characterized by the production of low-cost oil barrel, due to the shipping and storage cost pending the availability of demand.
  • All possibilities are plausible for the shale oil sector. However, it is likely that its production will shrink over the medium term as investments in the sector have declined by 20 percent and its continuous expansion since 2014 will stop. This may threaten the US position as the world’s biggest producer. The US oil market is characterized by a significant financial weight. Investment in this sector is enormous, reaching 30 percent of the number of daily transactions in the US commodity exchange.
  • Although governments have adopted financial and monetary incentive programmes, the effects of those incentives on oil demand could be minimal in view of the tough restrictions on travel, especially that expectations with regard to global economic growth are highly uncertain and that the high level of fluctuations in markets poses a challenge in predicting oil prices and the level of global oil consumption in the coming months.
  • The different oil markets face the challenge of countering clean and renewable energy whose share in the global oil mix is increasing and which is replacing fossil fuel. However, the current low oil prices will enhance oil’s presence as one of the main sources of energy in the short and medium terms despite calls to benefit from the decline in oil demand as a result of the crisis to start thinking of giving up oil and fossil fuel. However, this is difficult to materialize in view of oil’s current high competitiveness compared to other energy sources (in the short and medium terms).   

b. Consumption markets

Consumption markets will be affected by the low consumption of the airline, tourism and transport sectors and the weak global economic growth. The degree of flexibility of those markets will be determined as follows:

  • Consumption markets now assume a greater role in price recovery and restoring life to the oil market in general through the suggestion by some to use the available oil to fill in the strategic stocks of consuming countries to create a demand in the market that is commensurate with supply and that would save the oil sector from a fate that could be adverse for all.
  • The possibility of a change in demand due to the change of future consumer behaviour as a result of the coronavirus epidemic and the tendency by some to implement the home-working system as an integral part of the post-coronavirus working environment. This will decrease the increasing oil consumption in some sectors.[13] The Energy Information Administration expects that liquid fuel consumption will gradually rise above those low levels with the resumption of some commercial activities.
  • The US role has changed. It now plays the role of OPEC countries in coordinating globally with producers and standing for higher and more equitable prices that would facilitate continued production. OPEC countries themselves have started to shift to the US role in terms of commitment to free market principles. The US Energy Information Administration envisages that the US will return to its position as a net importer of crude oil and petroleum products in the third quarter of 2020 as a result of the increase in net crude oil imports and the fall in net exports of petroleum products.[14]

Main determinants

A number of determinants could contribute to channeling future investment into the oil and gas sectors. These are:

a. Degree of price stability and demand levels for oil and gas: current price fluctuations will discourage investors from getting involved in new investments in the oil and gas market in the short run pending identification of the future price pattern and the expected degree of profitability therefrom. According to International Energy Agency (IEA( projections, global oil demand has declined by nearly 29 million barrels per day in the second quarter of 2020 due to the economic implications of the coronavirus. This means that oil demand is likely to decline further in case the global economic lockdown remains as it is.

b. Duration of the economic crisis: as a result of the coronavirus crisis, the global economy has entered into a significant and sharp contraction crisis whose implications may last in the short and medium terms. This will lead to cutting any unprofitable or high-risk investment spending.

c. Size of the current stock and availability of future storage facilities: according to the energy research consultancy Energy Aspects, the world’s storage capacity is estimated at 900 million barrels.[15] Based on the current production pattern, declining demand and traders’ desire to store to benefit from the current price decline to make profit in case the markets open up, the storage capacity will be completely full during the upcoming months. This will lead to a catastrophe in the oil market unless demand is improved to withdraw those stocks. Under the circumstances, the investment decision in the oil market becomes extremely difficult. Things get even more difficult in onshore markets where the storage problem gets worse due to their distance from the sea.[16] Figure 2 shows the high development percentage in the inventory rates of OECD countries (which are considered among the world’s main oil consumers) over the upcoming period.

d. Proportion of contribution to the global energy mix: with the increasing reliance on clean energy and tendency to invest in natural gas in the medium and long terms, many global energy companies will be attracted more to the gas sector than to the oil sector which suffers from significant structural and price problems.

Future scenarios for investment trends in the oil sector

Considering the current crisis in the oil sector, global energy companies are cautious about making any new investments in the sector. In view of the numerous bankruptcies in the oil sector, especially in companies operating in the area of high-cost oil, such as shale oil, the following three scenarios could be considered regarding the investment trends of global companies in the oil sector:

First scenario: takeover by major oil companies of the oil market after the crisis as a result of the collapse of small companies due to bankruptcy or acquisition by large companies. According to Rystad Energy estimates, if oil prices remain close to 20 dollars in 2020-2021, more than 500 US companies could go bankrupt, which is the largest collective company bankruptcy figure in modern history. Some companies in the US market have already started to drive small companies operating in the shale oil industry toward bankruptcy to take them over. This means that the energy sector will shift towards centralization and increasing control by major oil companies, such as Exxon, Shell, BP and other companies in the sector because they are more capable of affording the current crisis compared to small producers and because those companies tend to be horizontally integrated, that is they are active along the value chain of the energy sector, including refineries. Those companies are likely to offset their losses in crude oil through reducing the operational costs of the production process in those refineries. Since these are global companies, they have ample reserves and assets distributed all over the world and not just in oilfields. They also boast diversified financial portfolios, and their growth prospects are linked to external financial markets. Goldman Sachs bank has confirmed that the potential consequences of the crisis will drive major companies towards enhancing their best assets and getting rid of their worst assets. Consequently, when the industry returns after the crisis, few companies will have high-quality assets.

Second scenario: intervention by different countries to save companies operating in the oil market from collapse. This would ensure the current multiplicity in the market and prevent control by major poles over the scene.

Third scenario: growth of the size and strength of major companies but not fully so that it would take control of the market alone as attempts by countries to save small and medium countries will be successful to a certain extent (and not fully) in saving some of those companies which will be able to overcome the post-crisis stage.

The third scenario is the most plausible considering that countries will not abandon their energy companies without support at a time when they would be under pressure by major companies. This means that almost equivalent pressures will exist from both sides resulting in the materialization of the third scenario.

Future scenarios for price trends in the oil sector

The oil sector is currently experiencing uncertainty with regard to the future of prices, particularly after the hard collapses of prices in April 2020. Prices and the future of the market remain exceptionally uncertain. Based on the current indicators and the different future dimensions, one of the following two scenarios could be expected to materialize:

First scenario: a recovery in prices as a result of the decline of investments in the oil sector. This amounts to voluntary production cuts together with the current OPEC+ cuts. This will lead to a drop in supply and potentially improved demand in the medium term as a result of the start of recovery from the coronavirus crisis. While this would amount to improved prices, it may not be up to the expected percentages or levels. It is expected to be around 30-40 dollars until mid-2021. That is, oil markets will start to regain balance immediately after the OPEC+ deal to cut production takes effect at the beginning of May 2020. However, a significant price increase is unlikely in the near future due to the high levels of global stocks.

Second scenario: the occurrence of a complete collapse in oil prices as a result of continuing storage and the existence of forced production by some producers who cannot stop production, together with a potential drop in demand for a long period in case the negative economic impact of the coronavirus crisis continues. This will create a state of paralysis in the oil market followed by a full collapse of prices.

The first scenario seems the most plausible in view of the desire by many countries to partially open up economies and return to business. This will improve demand for oil together with the possible decline in supply as a result of halted investments in the sector which will lead to a price recovery, albeit on a narrow scale. 

Endnotes and sources

[1] Goldman Sees Global Oil Testing Storage Capacity in 3-4 Weeks, available at: https://www.bloomberg.com/news/articles/2020-04-27/goldman-sees-global-oil-testing-storage-capacity-in-3-4-weeks?srnd=premium-middle-east&sref=mmeFTDW1, access on: 26-4-2020.

[2] The Next Chapter of the Oil Crisis: The Industry Shuts Down, available at: https://www.bloomberg.com/news/articles/2020-04-26/the-next-chapter-of-the-oil-crisis-the-industry-shuts-down?srnd=premium-middle-east&sref=mmeFTDW1, access on: 26-4-2020.

[3] Monthly Energy Review, available at: https://www.eia.gov/totalenergy/data/monthly/pdf/mer.pdf, access on: 26-4-2020.

[4] After COVID-19, The Oil Industry Will Not Return To “Normal”, available at: https://www.forbes.com/sites/walvanlierop/2020/04/05/after-covid-19-the-oil-industry-will-not-return-to-normal/#7f3fe9fe281e, access on: 27-4-2020.

[5] Saudi Arabia’s pyrrhic oil war triumph, available at: https://www.petroleum-economist.com/articles/politics-economics/middle-east/2020/saudi-arabia-s-pyrrhic-oil-war-triumph, access on: 26-4-2020.

[6] COVID-19: What it means for the energy industry, available at: https://www.pwc.com/us/en/library/covid-19/coronavirus-energy-industry-impact.html, access on: 26-4-2020.

[7] How is coronavirus hitting global energy and commodity markets?, available at: https://www.woodmac.com/nslp/coronavirus-research-hub/, access on: 26-4-2020.

[8] How coronavirus is driving down LNG demand in Asia and Europe – and hitting supply, available at: https://www.woodmac.com/news/opinion/how-coronavirus-is-driving-down-lng-demand-in-asia-and-europe-and-hitting-supply/, access on: 26-4-2020.

[9] LNG poised for European market share battle, available at: https://www.petroleum-economist.com/articles/midstream-downstream/lng/2020/lng-poised-for-european-market-share-battle, access on: 26-4-2020.

[10] 10 factors that influence upstream production shut-in decisions, available at: https://www.woodmac.com/news/editorial/10-factors-that-influence-upstream-production-shut-in-decisions/, access on: 26-4-2020.

[11] Oil Prices Plunge On Grim IMF Economic Forecast, available at: https://oilprice.com/Energy/Oil-Prices/Oil-Prices-Plunge-On-Grim-IMF-Economic-Forecast.html, access on: 26-4-2020.

[12] Stocks, crude plunge on economic data, oil oversupply, available at: https://www.reuters.com/article/us-global-markets/stocks-crude-plunge-on-economic-data-oil-oversupply-idUSKCN21X001, access on: 26-4-2020.

[13] As coronavirus shocks the energy sector and economy, is now the time for a new energy order?, available at: https://www.weforum.org/agenda/2020/04/energy-oil-gas-electricity-sustainability-economy-covid19-coronavirus-pandemic-market-stability/, access on: 26-4-2020.

[14] Short-Term Energy Outlook, US Energy Information Administration, available at: https://www.eia.gov/outlooks/steo/pdf/steo_full.pdf, access on: 26-4-2020.

[15] The Oil Inventory Challenge, available at: https://www.csis.org/analysis/oil-inventory-challenge, access on: 26-4-2020.

[16] Oil Market Report - April 2020, available at: https://www.iea.org/reports/oil-market-report-april-2020, access on: 26-4-2020.

Latest Featured Topics