Tumbling Oil Prices - An Uncertain Future for the Global Oil Market

As an industry operating through long megacycles of shifting supply and demand riddled by shocks along the way, it does not come as a surprise that the COVID-19 pandemic has had such a detrimental impact on the price of oil and the energy sector as a whole. Therefore, it is imperative to consider the future implications that the current crisis is having on the oil industry, and how this will impact the health of the world economy in the years ahead.

The Overall Picture

The catastrophic impact has been underpinned by the unprecedented drop in demand for oil and oil products in turn resulting in prices plunging and non-payments of utilities bills by end-consumers having a damaging effect along the entire energy value chain, affecting upstream (exploration and production of oil and natural gas), midstream (anything required to transport and store crude oil and natural gas before they are refined and processed into fuels), downstream (turning crude oil and natural gas into the finished product), and service companies [1]. Oilfield services groups which range from drilling wells to installing pipes for producers, have been most susceptible to laying off workers as the demand has perished for the assistance that they provide [2] with many companies across different sectors ceasing, decreasing or delaying capital expenditures, in other words, reducing the amount of physical assets bought or current assets upgraded, to the sum of $85bn from over 100 tracked companies across the industry [3].

In the past couple of months, the international benchmark, Brent Crude, has been cruising steadily between the ranges of $40-$45/barrel however, on the 20^th of April 2020, oil prices made history by entering negative territory for the first time with the US benchmark oil contract, known as West Texas Intermediate (WTI) ending the day at minus $37/barrel [[4]](https://www.bruegel.org/2020/04/covid-19-is-causing-the-collapse-of-oil-markets-when-will-they-recover/). However, oil prices remain too low for companies to profitably resume drilling, and oil-storage facilities are suffering, particularly in the U.S., where there is enormous pressure for storing excess barrels of oil, with free global storage capacity currently estimated at 500-600 million barrels [5[]](https://www.bruegel.org/2020/04/covid-19-is-causing-the-collapse-of-oil-markets-when-will-they-recover/).

The Bitter Situation in the U.S.

In the US, the shale and fracking industry has been hit particularly hard, namely because it requires very high prices of oil to operate profitably having already been setback by high levels of debt. Shale and fracking companies make up more than 11% of the entire US junk bond market and are the biggest issuers of junk bonds (high-yield, high-risk securities) [6]. Widespread bankruptcies are expected unless large oil companies consolidate their power through greater downstream sectoral involvement i.e. by buying out any distressed assets. For instance, Chevron and ExxonMobil are in a stronger position than their pure shale rivals as they have moderate levels of debt and ongoing cash flow from previous investments in the Middle East [7[]](https://www.thenational.ae/business/energy/why-consolidation-will-be-key-for-oil-companies-1.995627). Furthermore, big banks including JPMorgan Chase & Co and Wells Fargo & Co are setting up independent companies to directly own oil and gas assets in the sector of shale which may temporarily safeguard the future of shale companies while ensuring that major U.S. lenders don’t accumulate losses on loans if energy companies go bankrupt [8]. The companies that the banks are setting up could manage oil and gas assets until conditions improve enough to sell at a meaningful value, effectively buying time for energy producers.

Signs of an Early Recovery and OPEC+’s Intervention

The rebound in oil consumption in China has helped to stabilise crude oil prices at a higher level with the nation capitalising on the low crude oil prices catalysed by the Russia-Saudi Arabia oil price war and the pandemic. However, China may face a similar struggle to the U.S. by having to sell excess refined fuels to regional markets[9].

The cause of why oil markets are under enormous strain is ultimately the solution; oil markets are facing low demand coupled with limited storage – this will continue to persist, unless global demand is re-established. The world’s top oil producers are mitigating against a prolonged downturn; on the 12^th of April 2020, the OPEC+ alliance agreed to cut global oil production by nearly 10% to rebalance the oil markets and to end the oil price war between Russia and Saudi Arabia. This appears as a promising contingency plan however in reality, an increase in oil prices may not materialise for several reasons. First off, the OPEC+ alliance is typified by being unstable. Russia, since joining forces with OPEC in 2016, has frequently ignored the terms of deals [10] by for example, exceeding quotas allowed by previous deals and so the supply cuts may not be as large as intended if the member states failure to adhere to the limits on output. Another problem arises if we see further spikes in COVID-19 cases as it may result in greater localisation of supply chains further suppressing demand. The investment banking company, Citigroup, projects that if all goes as planned, and all the member states obey the terms of the deal, prices could rise to the $60s or $70s in 2021 [11].

The Multi-Faceted Impact on the Gulf States

According to the IMF, oil revenues in the Middle East and North Africa, fell from over $1trn in 2012 to $575bn in 2019 [12[]](https://www.economist.com/middle-east-and-africa/2020/07/18/the-end-of-the-arab-worlds-oil-age-is-nigh). Despite the decline in oil revenues, the Gulf Cooperation Council (GCC) a political and economic alliance of six countries in the Arabian Peninsula: Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates, remains in a relatively strong position to weather the storm with the GCC states having relatively low debt, access to accumulated reserves, the ability to borrow relatively cheaply on international markets and the most influential actor in the GCC, Saudi Arabia, being a swing producer with the ability to increase or decrease the supply of oil relatively easily. Prior to the pandemic, Saudi Arabia’s Sovereign Wealth Fund had about $2bn dollars invested in US listed stocks, which have now risen to about $10bn [13[]](https://www.soas.ac.uk/economics/events/01jun2020-oil-markets-and-the-covid-19-pandemic-webinar.html) and with foreign reserves exceeding $444bn, it has the capacity to cope with low prices in the short-run.

Meanwhile the nations adjacent to the GCC including Iran, Iraq and Algeria are highly oil dependent facing severe fiscal pressure and unrest from the resource curse. This is because their budgets are not adding up anymore. For instance, Algeria needs the price of Brent Crude to rise to $157/barrel in order to break-even. Therefore, the Algerian government has decided to cut spending by half [14[]](https://www.economist.com/middle-east-and-africa/2020/07/18/the-end-of-the-arab-worlds-oil-age-is-nigh). The projected earnings of selling oil this year by the Arab countries is $300bn which is nowhere near enough for cover expenses [15[]](https://www.economist.com/middle-east-and-africa/2020/07/18/the-end-of-the-arab-worlds-oil-age-is-nigh). Therefore, governments are taking drastic measures to try bolster the economy.

There is also the issue of migrant workers in the Gulf; poorer citizens in Saudi Arabia will be hit hard by the cuts to public expenditure, particularly as Saudi Arabia is the second largest source of remittances in the world [16[]](https://www.soas.ac.uk/economics/events/01jun2020-oil-markets-and-the-covid-19-pandemic-webinar.html) Furthermore, migrant workers in Saudi Arabia are often bound to the employer, banned from seeking alternative employment, unable to leave the country until their contract ends and having to pay recruitment fees. And in order to dampen the impact of the low oil prices, Saudi Arabia has implemented contractionary fiscal measures such as suspending a cost-of-living allowance for state workers which many migrant workers will bear the costs of.

Dire Future Prospects for the Global Oil Market and a Push Towards a Green Recovery?

According to the IEA Oil Market Report – April 2020, global oil demand is expected to fall by a record 9.3 millions of barrels/day year-on-year in 2020 [17[]](https://www.pv-magazine.com/2020/04/24/impact-of-covid-19-on-the-global-energy-sector/) and other forecasts by McKinsey & Company suggest that oil prices will only recover to pre-crisis levels in 2021 or 2022 ($50-$60/barrel) [18[]](https://www.mckinsey.com/industries/oil-and-gas/our-insights/oil-and-gas-after-covid-19-the-day-of-reckoning-or-a-new-age-of-opportunity). Besides the obvious impact that the coronavirus pandemic has had, oil and gas exploration and production (E&P) companies face increasing scrutiny, being demanded to act on climate change, making oil exploration a highly controversial activity.

Despite European E&P companies striving to be the leaders of the transition to renewable energy, they are hindered to pursue this on a global scale, by the high cost of the process and because many frontier markets lack a transparent regulatory environment, as well as commercial infrastructure for these assets to generate returns [19[]](https://www.ft.com/content/90c4f600-b035-4800-be68-d28fd0c4e3ee).

Furthermore, COVID-19 is impacting the renewables sector by delaying deliveries from China for many clean energy technologies including solar panels, wind turbines and batteries therefore, energy companies are not able to comply with deadlines for equipment installation [20[]](https://www.pv-magazine.com/2020/04/24/impact-of-covid-19-on-the-global-energy-sector/). The negative effects of the pandemic are further reinforced by the fact that cheaper energy leads consumers to use it less efficiently, and may damage the progress made in the clean energy transition. However, the pandemic has helped to stifle pollution levels through decreased industrial production therefore, a ‘green’ agenda should not escape from the list of priorities for policymakers and regulators.

The turmoil that the global oil market has experienced over the last few months may just help to create a greater impetus for cleaner energy sources in turn gradually squeezing out the superior role that the oil industry has played. Instead, if producers and consumers are purely driven by the lower oil prices, this may instead help reinvigorate the oil industry and allow it to resume normal activity once again.