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Oil demand – Over the hill and far away

Responsible Investing

BNP Paribas Asset Management
 

Oil demand may recover in line with the post-pandemic bounce-back in economic growth. However, longer term, it will resume the downtrend that was visible already amid the structural pressures on demand that look likely to be reinforced by the changes in behaviour resulting from the measures taken around the globe to contain the spread of COVID-19.

Fossil fuel vs. renewables: a bleak outlook vs. a brighter one

For investors, this means that the outlook for the oil industry, and by extension fossil fuel companies generally, is bleak. Conversely, the prospects for renewable energy sources is much brighter.

The secular downtrend in oil demand looks likely to be strengthened by the lasting effects of some of the pandemic-related measures, such as an eventual preference for working from home and attending conferences via a video link rather than in person.

Factors such as localisation of production and a now more apparent need for less dependency on foreign suppliers and imported resources should further raise the economic and environmental attractions of renewables at the expense of oil and other fossil fuels

One-offs and structural factors affecting oil demand

One could take the view that the turmoil in the oil market, and thus in the oil industry, is temporary. Meetings of oil producers have failed to curb production to support prices amid a glut of oil and in the face of a slump in demand as COVID-19 related shelter-at-home measures have effectively closed down entire economies.

With persistent supply overwhelming crumbling demand and onshore storage at maximum capacity, oil prices have fallen to below zero, exacerbating the crisis in the oil industry and raising the spectre of debt defaults and bankruptcies. While, arguably, these have been developments in only the last two months, oil was already under increasing structural pressure before the pandemic.

Long-lasting pressures on oil demand

Measures to mitigate or adapt to the effects of climate change through de-carbonisation were favouring renewable energy. So, too, were the steadily improving economics – falling costs – of renewables. There are also popular calls for governments to improve air quality, particularly in cities in developing countries such as China and India, and to reduce their dependency on imported fuel or specific suppliers.

These efforts may slip down the agenda as governments focus on the health crisis, but they will likely quickly reassert themselves afterwards. They might even gain in prominence as governments step up spending to rekindle their economies. After all, climate change phenomena such as global warming, droughts and flooding pay no heed to viral pandemics.

A trade-war related refocusing on insourcing and a retreat from globalisation in favour of localised trade and manufacturing were already putting further long-lasting pressure on oil demand. This has only been exacerbated by the response to the pandemic now that millions of people are working from home, flying little and avoiding conferences and other large gatherings.

Oil demand – over the hill

Add in the largest ever drop in oil consumption as a result of the widespread lockdowns and the notion that global oil demand may already have peaked does not look far-fetched. The biggest source of supply in recent years, US oil production has almost certainly now peaked and the industry – more specifically, US shale oil producers – faces an existential crisis.

Are we jumping the gun? Are international energy agencies not forecasting a recovery in consumption to above the all-time high set in 2019? They are, but the combination of structural pressures on demand and behavioural work-life changes might outweigh the effects of economies returning to normal. This will in fact be a ‘new normal’ marked by gradual exits from the containment measures and a profound rethink of economic and business models.

Structural pressures and behavioural changes

Consider the energy efficiency improvements already achieved. These have been growing exponentially in recent years and, in our view, that pace is likely to continue.

As an example, electric vehicles are already far more efficient than petrol or diesel-powered cars and populous countries such as China and India are competing with Europe on electric vehicle penetration. As this trend steepens in the coming years, it would logically have profound effects on fossil fuel consumption.

Consider the likelihood that millions of the people now confined to their homes will opt to work from home even after the crisis, decimating fossil fuel-guzzling travel. Post-pandemic cost-cutting looks likely to curb business travel.

Large gatherings for business, entertainment, sport and religion could largely become a thing of the past, for public health reasons. In short, concerns about a second wave of COVID-19 could permanently change behaviours.

Oil demand – doubts over a V-shaped recovery

These are powerful reasons to believe that the fall-out from the demand destroyed by the COVID-19 crisis could be permanent and that a ‘V-shaped’ bounce in demand later this year is unlikely.

What then of the outlook for the oil industry? It is particularly sombre for the US shale industry. These heavily indebted companies were not making money while oil prices were high and there is no reason to expect they can do so when oil prices are (this) low. The prospects of defaults are growing and while the US government may step in to save jobs, with it or US lenders possibly taking operational control, investor patience is wearing thin.

That in fact might also apply to investor interest in any oil major that is not taking climate change and the economics of renewables seriously and is not redirecting capital spending to sustainable business, even if the oil price does eventually – possibly after a year and a half – recover from the double whammy of overproduction and demand destruction.

This article is based on a recent BrightTALK webinar with Mark Lewis in which he discusses the potentially lasting impact that COVID-19 and global lockdown will have on oil demand. Listen to the full webinar here “Oil: Demand on Remand”.


 

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