Fuel To The Fire: COVID-19 And Oil Market Turmoil

June 17, 2020

OVERVIEW

In early March 2020, chaos hit the global oil markets. A dispute over supply between Saudi Arabia and Russia sent prices crashing 25 percent – their biggest one-day drop in almost 30 years. Then, in April, U.S. oil prices briefly fell into negative territory as traders started paying people to take oil off their hands to avoid the high costs of storage. This high drama on the world’s financial markets was all played out against a backdrop of the global novel coronavirus (COVID-19) pandemic.

The roots of this crisis began in 2019, when a combination of excess supply and signs of slowing economic activity in China and elsewhere had driven down prices in 2019. Then, as COVID-19 spread around the world causing travel lockdowns, stay-at-home orders and shuttered businesses, the market plunged.

Oil demand dropped 29 million barrels a day in April from a year earlier, to levels not seen since 1995, according to the International Energy Agency.

All this has had a significant impact on businesses and their ability to plan and make effective decisions.
“Oil price volatility has widespread impacts,” says Euan Nicolson, chief commercial officer for Energy at Aon. “For some businesses, lower oil prices can be a positive, resulting in lower fuel prices or raw material costs. For those across the oil industry, however, the price plunge might lead to delayed or deferred drilling projects, with ripple effects across the chain of contractors and suppliers that support the industry.”

IN DEPTH

Crude oil prices are about half what they were at the start of 2020, hit by the COVID-19 pandemic’s impact on economic activity and travel.

By early June, production cuts by the Organization of Petroleum Exporting Countries (OPEC) and allied countries boosted prices somewhat, as did the first stages of reopening economies from pandemic shutdowns. Still, prices were far below earlier levels.

Across The Oil Industry, Different Impacts

The impact of depressed oil prices varies across the industry.

Upstream Sector: Searching For Oil And Gas Supply

“Upstream companies have declared almost no drilling activity for the rest of 2020, dramatically changing their original plans for production pre-COVID-19,” says Daniel Ocampo, Latin America Energy Specialty Leader at Aon.

Offshore drilling is very capital intensive, with long timelines between discovery and production. In the current price climate, many offshore drilling projects are therefore being deferred or cancelled.

Operational budgets have also been reduced, which, in some cases, could include deferred maintenance, says Nicolson. That has a knock-on effect on the contractors that supply drilling rigs or oil field service companies that are seeing reduced demand for their services.

Among onshore producers, while production costs have come down, shale oil extraction remains an expensive process. There, too, falling prices and reduced demand have led companies to cut production, again with a severe impact on the contractors supporting the industry. North American rig count from Baker Hughes is 70 percent lower than last year – it was at 284 on June 5, down 691, says Nicolson.

Downstream Sector: Creating Products From Crude Oil And Natural Gas

The effects vary as well for “downstream” oil industry companies. The drop in demand for fuel, gasoline and diesel has hit refiners hard, with many slowing or even shutting down production, says Ocampo. Conversely, many petrochemical companies are benefitting from the low prices for the oil on which their products are based.

Companies that have been forced to cut salaries or lay off employees face issues of employee retention and motivation. Additionally, for some, the availability of key site personnel due to COVID-19 is impacting the staffing levels of operations, integrity and engineering functions. Meanwhile, companies that have shut down refining operations or processing plants must recognize strict adherence to procedures in restart operations – often the riskiest stage of the process cycle, says Nicolson.

Going Forward, An Uneven Recovery

As oil markets move back toward something resembling normal, recovery will be uneven across different areas of the industry, and there will be volatility, suggests Nicolson.

“As economies begin to open, supply and demand will need to adjust – and if the pandemic hits in waves – oil demand is likely to spike and drop accordingly,” says Nicolson.

“The surplus of product across the Latin America region has filled storage capacity. The real challenge begins as demand increases gradually and the industry needs to get this surplus moving first,” says Ocampo. “We foresee that this impact will drag into the last quarter of 2020 and even into 2021.”

Under normal circumstances, many industries would stand to benefit from low oil prices. Retailers, restaurants, travel and entertainment could see increased spending by consumers paying less to fill their cars’ gas tanks. And low fuel prices are a benefit for the transportation industry. But in today’s COVID-19 landscape, those low prices haven’t offered much reward with many consumers staying close to home and spending less, and rising unemployment

Taking Lessons From A Crisis To Increase Resilience

The pandemic and its impact on energy consumption has prompted discussions about what the energy industry looks like after COVID-19.

More companies are outlining plans for decarbonization and publicizing carbon net zero target dates, Nicolson says, and, as economies regain speed, some countries are also expressing interest in adopting different approaches to meeting future energy demand and stimulating growth through green investment.

“Green energy and renewable energy sources could see a spike in Latin America in the next five years,” says Ocampo. “Local legislations were already pointing to exploring new energy sources. This crisis could accelerate the inevitable switch.”

In the energy industry and beyond, companies are taking this opportunity to learn from current events to increase their resilience going forward, says Greg Lowe, global head of sustainability and resilience at Aon.

“Resilient businesses understand that operating environments are dynamic and changing,” says Lowe. “Adapting accordingly is critical to coming out of this in a stronger position than before.”

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