Oil: we have entered a new world and there is no way back

Oil—aka Black Gold, the lifeblood of the global economy, or simply The Prize—is in deep trouble. Like something from Alice in Wonderland, the last few weeks have seen supposedly impossible events. The US president intervened with Russia and Saudi Arabia to try and force prices up. Despite the biggest production cutbacks in history, the price of the US benchmark oil went negative earlier this week. That bizarre spectacle reflected the peculiarities of US contracts and storage infrastructure. The real news is the global price; the real question is how low will it go and for how long.

“Normally” sustained over $60/barrel (as widely indexed to Brent crude), after a limpid rally earlier in April, the global price this week has gone down to $20/barrel. If anything like that persists, hundreds of the smaller energy producers will go bankrupt, petro-regimes may fall, and world geopolitics could be rewritten. Oh, and the bottom may have dropped out of your pension funds.

The common assumption is that thanks to Covid-19, the oil markets have caught a nasty bout of flu and will recover to something like normality, as they always have before. They won’t.

If it were “just” Covid-19, oil would recover. But it already faced two other challenges. The first was over-supply. The oil price collapse started just before the Covid-19 crisis broke, with the Saudi-led OPEC unable to agree production cuts with Russia. Prices close to $60 throughout 2019 were bringing in ever-more US shale oil, challenging both OPEC and Russian production. It was encouraging other new producers, including from Africa. According to the textbooks, as the biggest and cheapest supplier, Saudi Arabia could win any price war as it has done before, thus stabilising the market.

However, the Saudi regime depends on high oil prices to balance its books. Russia is much more diversified, and is equally concerned about US shale gas exports undermining its pipeline gas markets—which mostly involve oil-linked prices. Global liquefied gas (LNG) prices had already collapsed—first in the Atlantic basin and then more dramatically in Asia. One of the world’s leading gas research centres, the Oxford Institute of Energy Studies, projects that the LNG glut will last a decade, at prices which can compete with coal for power generation and oil in key petrochemical uses.

For Russia, crashing the oil price is a strategic game with an upside. Covid-19 has, however, turned the battle into a rout. Logically, shale oil should crumble first. The crashing price has indeed enabled Trump to offer enough cutbacks to create a façade of a three-way deal. But we can also bet that a significant chunk of the world’s largest-ever stimulus package will try to maintain US production, come what may. So Covid-19 could indirectly amplify the strategic supply glut.

The Saudis can no longer win a price war. Under pressure from the US, they had to sue for a temporary peace—while losing both power and a shrunken share of a cratered market. Even an unthinkable deal between the US, Russia and Saudi Arabia could not stop the price sinking back to one third of its “normal” level.

A massive market shakeout is now inevitable. In time, this would be expected to lead to the usual cycle of recovery. It is after all etched into the psychology of the industry that, in the depths of the last great price slump, in 1999, the Economist predicted a world “awash with cheap oil”—and had to rapidly eat its words. Supply fell, demand soared, and OPEC re-established its grip.

So to the second, strategic challenge—also amplified by Covid-19—of the multiple pressures on oil demand. In oil’s premier market of transport, growth in the west had largely stalled anyway over the past 10-15 years. The short-run impacts of Covid-19 are obvious. But the pandemic seems peculiarly targeted towards this assumed bastion of demand.

Of course people will resume travel. Yet by then we will all be more than familiar with remote working and video conferencing. It will be routine for businesses to ask if the time and strain—and for international meetings, cost and jetlag—of a physical meeting is really justified compared to a video conference. Domestically, Covid-19 will have accelerated the capacity for, and pre-existing trend towards, homeworking. Even in our personal lives, having experienced that Zoom celebration or a curry evening shared with friends on Skype, we may think twice before travelling so far.

We have learned other things. The citizens of developing country megacities had become partly anaesthetised to appalling levels of pollution; they have experienced again what clean air is like. One great paradox of Covid-19 is credible evidence that the reduced air pollution in China has saved more lives—perhaps far more—than the virus has killed.

There will be a renewed awareness of the fragility of our complex societies, of global interconnectedness, and the benefits of taking heed of scientific warnings and prescriptions.

The pandemic occurred against a backdrop of unprecedented concerns about climate change and accumulated impacts of extreme events. Anyone who thinks that Covid-19 has displaced this may be in for a shock. One huge psychological impact is discovering that many advanced societies are less resilient than we thought. Those that seem to have coped the best were those that had learned from the past—including SARS—and invested, prepared and then followed the scientific evidence as it emerged.

Most of all, this has happened just as cleaner alternatives have become attractive. In 2019, over 2m electric vehicles (EVs) were sold—still relatively few, but a growing force. Of course low oil prices will reduce the cost of conventional fuel, but the crude price is only a modest share of the overall cost of driving in most countries. EVs are cleaner, more efficient, and—given their intrinsically greater simplicity—on the cusp of becoming cheaper to buy than conventional cars. The pace of innovation, and the demand for cleaner transport, may easily outpace the falling price of crude.

Moreover, with wind or solar electricity now cheaper than fossil fuels in many regions, EVs might also sell valuable balancing services back to the power grid. In Europe and many Asian countries at least, stimulus money could well—and should—accelerate the technology and rollout of charging infrastructures. After all, these countries, most of them structurally dependent on oil imports, are unlikely to want to expose themselves to the vagaries of the new “super-OPEC” when they have better alternatives to hand.

In sum: coronavirus has just prematurely thrown the world’s most valuable commodity over a cliff towards which it was anyway stumbling this decade. In 2019, oil demand breached 100m barrels a day for the first time: it may well be the last. Covid-19 has already ensured that 2020 demand will be much lower. Some inevitable post-Covid-19 bounce does not mean that oil demand will ever again reach triple figures. A previously unthinkable US-convened semi-cartel with Russia and OPEC could probably cause price spikes, but seems scarcely stable in the long run. The cost of the dramatic and strategically premature price collapse could still be high volatility, particularly if Middle East regimes fall or take to conflict in fiscal desperation. But we have already entered a new world, and there is no way back to the old.

 

A version of this article first appeared in Asia Times