The second wave of the coronavirus may force OPEC to up the oil cuts, but that’s just the beginning of the issues the sector will have to face. Is oil doomed to fail, as Joe Biden claims, or will it fuel the economic recovery after the crisis, as Donal Trump argues? Poland may win and lose in both of these scenarios – writes Wojciech Jakóbik, editor in chief at BiznesAlert.pl.
The barrel vs. lockdowns and U.S. elections
The news on the return of lockdowns in western countries caused a drop in Brent and WTI prices by a few percent. The loss was made up in the next days, which was probably related to the possibility that Donald Trump could be reelected and leave America’s policy on its current course. The Joe Biden presidency is perceived as an opportunity to accelerate the energy transition in the U.S. and to gradually phase out oil. “I would transition away from the oil industry, yes,” Biden confirmed during a presidential debate with Trump. The incumbent president then used this statement to win voters from the so-called shale states, especially Pennsylvania. According to the economic program of the current U.S. president, the oil and gas sector is and will remain one of the engines behind U.S. economy. And at least for now that is indeed the case. The shale revolution not only decreased CO2 emissions in the States, but also created thousands of jobs. However, if it is Biden who is right, this state of affairs is not here to stay. The full election results were not known before this piece was published (Polish version – transl.). Only after the winner is announced, will we know how Biden’s statement impacted his result. On the 5th of November at 6:30 a.m. the Brent was at USD 40.69 per barell, WTI at USD 38.61. Both went down that day, but since the 2nd of November they have been going up. The presidential election was on the 3rd. An objective analysis of oil prices will be probably possible after the election result is factored into the oil price next week. However, the impact of the second phase of the coronavirus on the barrel has been visible at least since the second half of October, when restrictions were being reinstated. The price of oil will be most impacted in the coming months by the scale of the social distancing policies. However, the coronavirus’s weight on the petroleum sector is just a medium-term issue. The world is hoping that in the next few years at most, the pandemic will be taken under control. So, what needs to be looked at is the decades-long perspective for the sector. And the future does not seem to be very promising for oil traders, because it looks like their trade may sooner or later become obsolete.
Is Biden right to predict the demise of oil? It is worth remembering that it was in 1956 that the end of oil was first foretold. The author of the prediction was Marion King Hubbert. He believed oil production would peak in 1970, after which output would gradually decline. In 1998 Colin J. Campbell and Jean F. Laherrere updated Hubbert’s calculations, and decided the peak of oil production would occur between 2004 and 2005. However, after 2010 a revolution started in the U.S. and questioned that assumption. Today Americans export hydrocarbons thanks to technological advancement, which allowed them to grab new deposits and lower extraction costs to a point, which allows some wells in the Permian Basin to maintain profitability at a barrel price around USD 30. These new possibilities undermine Hubbert’s prognosis from 60 years ago, because his prediction assumes a linear growth, and then a drop in extraction; and it was based only on deposits available in 1956. Whereas exploration is ongoing and new oil deposits are discovered across the world. There are still various peak oil forecasts. Rystad Energy claims it will happen in 2028. The International Energy Agency thinks the coronavirus pandemic will cause it in the 2030s. Whereas, according to OPEC the peak will happen in mid 2040s, but it may have already happened in developing countries, at least according to Britain’s BP, which claims peak oil had already taken place. The market seems to believe in the demise of oil, which is evidenced by the fact that oil companies are diversifying their portfolio like a Vitol oil peddler that is investing in used cars. On the other hand, Exxon and PGNiG are not losing hope, which I am writing about below. The oil cartel OPEC and its gas counterpart GECF are also optimistic. The organizations have recently published a statement summing up their first ever joint meeting, in which they argue that hydrocarbons will “always” remain an important part of a low-emission economy. “Although the current market conditions and lockdowns are multiplying throughout the world, we believe that oil and natural gas industries will always be an essential element in achieving a low-carbon energy system globally and regionally and, that they will support the post-pandemic economic revitalisation,” OPEC and GECF said in the statement published on the 4th of November. Therefore, it is worth taking a look at the situation on the oil market, and at the impending transition, which may alter it forever.
The second wave of the coronavirus is undermining the OPEC deal
The oil market is afraid of a new price crisis. It looks like the OPEC members may at least freeze, or maybe even tighten the agreement by increasing output cuts. Even though the petrostates may find it tempting to start a price war, as it would allow them to maximize the profits from oil sales, it would still end with another price crisis, a problem their state budgets cannot afford.
At first the OPEC+ deal introduced cuts in oil production by 9.7 million barrels between May and June 2020, then by 7.7 m barrels by December 2020 and by 5.8 m until April 2022. Originally the parties intended to revise the deal in December 2021. However, already in the summer changes had to be introduced, because some of the signatories failed to implement the agreement. Some were obliged to make up for the missing cuts, and at the same time increased cuts were prolonged until the end of July 2020. Aramco Trading, the daughter company of Saudi Aramco, believes that the current demand for oil across the world does not justify lowering the cuts in January 2021. The reason is the second wave of the coronavirus pandemic, which caused the reinstatement of social distancing rules and lockdowns in various states. Despite the expectation that the demand for oil will stay at the same level in China, other factors, such as increasing oil supplies in the U.S. and Libya restarting oil production, suggest there will be oversupply on the market. Whatever happens next, the fact is that the situation in the late Muammar Gaddafi’s country is now calm enough to produce over 800 thousand barrels per day (bpd). In the coming months that figure will grow to 1.3 million bpd. Despite that, Libya has declared it wanted to coordinate its production with other oil tycoons. However, it is not known how the cooperation will be impacted by the civil war and the fact that the country has two centers of power – in Tripoli and Benghazi. This issue, together with the possible return of Iran and Venezuela to the oil market may have a decisive impact on the effectiveness of the oil deal. However, at this point neither of these states has managed to effectively cooperate to limit the impact of U.S. sanctions on their oil export. In Venezuela oil export plummeted to 359 thousand bpd, leaving behind in the local ports an unused capacity equal to about 3 million barrels. Iran and Venezuela are trying to deliver oil between tankers to avoid U.S. sanctions, but without much success.
The next OPEC+ meeting will be held from 30 November to 1 December. Energy Intel learned that the members may want to extend the 7.7 m barrels cut by three months. In August Russia produced 9.824 m bpd, Saudi Arabia – 8.892 m bpd, OPEC – 24.045 m bpd, USA – 10.406 m bpd. In October 2020 Russia increased its output to 9.962 m barrels. It is worth pointing out that as part of OPEC+, Russia’s allowed oil production is 8.993 m bpd. However, Moscow did not have to face any consequences for failing to stick to the deal. It can continue to pretend it abides by the required cuts to up the oil prices, but it remains to be seen whether the market will swallow this narrative. Originally the OPEC+ participants agreed to revise the deal in 2021 and lower the cuts from 7.8 to 5.8 m bpd, but according to the Wall Street Journal the OPEC states changed their mind and want to increase the cuts agreed on by the OPEC+ group. However, Algeria, Russia and Iraq will reportedly support maintaining the cuts at the 2020 level. Algeria now holds the presidency in OPEC and has already warned about a new oil price crisis, if the oil deal is not frozen during the first months of 2021. The final decision may be take on 17 November during the joint committee for monitoring OPEC+. Russia’s energy minister Alexander Novak announced that he would assess the market situation with oil producers from his country on 19 November. Reuters’s unofficial sources suggest that the companies may want to delay lowering the cuts. Vladimir Putin admitted that “all options are on the table.”
Pavel Sorokin, the vice-minister of energy of Russia, determined that the future of the oil deal will depend on the market situation in mid-November. He also warned that Russia was able to quickly rebuild its extraction capabilities by implementing new projects. So, if the price war option wins, Russia will appear on the battlefield with new capacities to fight for the market with America and other producers. In spite of that, some Russian companies may want to support the deal to avoid a new price depression, even though it is possible it will occur anyway, because of the new lockdowns. However, Russian companies confirmed that Sorokin was right about their ability to revert to increased extraction in case the cuts are lowered. In 2020 Tatneft wants to produce 25.9 m barrels of oil, which is 13 percent less than the year before. The company announced it would take it a month or two to go back to its original output after withdrawing from the oil deal. It also planned its 2021 budget with the assumption that the average price of oil would be between USD 40 and 50 per barrel. Lukoil’s talks on producing oil in Iraq are interesting in this context, especially that Baghdad is the biggest violator of the oil deal. However, it did promise to make up the backlog in cuts by the end of the year. At this point that means 3.6 m barrels per day. Supposedly Iraq ordered the companies that have licenses to extract oil there – Exxon Mobil, BP and Lukoil – to lower production, but that goal is at odds with the plan to increase overall extraction in Iraqi oil fields in the face of the oil price crisis. After the success of the West Qurna 2 field, the Eridu field was supposed to have been next, but so far that didn’t happen. If the cumbersome limitations imposed by the oil deal were lifted, investments of this kind would become easier, and they are crucial for petrostates, such as Russia, to keep profiting from oil. However, on the other hand, a continued price drop would work against that same profitability and the goal to expand production. Therefore, the Russian state may back the new oil deal (freezing, tightening) and still snag more money from its oil companies. Mariusz Marszałkowski has written about this. Whereas the OPEC+ states may take either a moderate path and freeze the deal, or a radical turn and tighten its terms to increase the price.
This is just the beginning. The hydrogen revolution is the next blow
The coronavirus is just a taste of what is to plague the oil sector if it turns out its demise will actually happen. BP has admitted that at this point it was impossible to assess the impact of the virus’s second wave on the market, but that it was bigger than its analysts had initially expected. They were the ones who proposed the idea that the demand will not recover even after the pandemic, due to the energy transition that will bring about the end of oil. This is why the company will invest in low- and zero-emission technologies, similarly to PKN Orlen and the PGE Group. Just like Orlen and PGNiG, BP is also investing in hydrogen. The oil sector is divided over its opinions on the future of oil. Exxon Mobil and Equinor are hoping that output will increase, because they expect supply to go up as well. “Some believe the dramatic drop in demand resulting from the coronavirus reflects an accelerating response to the risk of climate change and suggest that our industry won’t recover. But as we look closely at the facts and the various expert assessments, we conclude that the needs of society will drive more energy use in the years ahead — and an ongoing need for the products we produce,” Exxon Mobil CEO Darren Woods argued. According to Exxon’s estimates the demand for oil will go up across the world from 100 m barrels in 2019 to 111 in 2040. The company uses this calculation to explain the necessity of new investments that will increase oil production by a third in the next four years. It assumes the present economic problems will significantly decrease the demand in the mid 2020s, but the eventual demand recovery will benefit those who decided to invest in efficient extraction, such as Exxon, not companies like BP or Shell that are now investing in renewables.
Whereas Equinor announced it wanted to make its extraction, hydrocarbon processing and usage by its clients climate neutral by 2050. To that end it wants to increase its RES capacity to 4-6 GW in 2026 and 12-16 GW in 2035. Before the end of 2019 it had 500 MW. The company will report on the progress in a separate segment of its financial documents. Despite the transition plans, Equinor does not give up on developing hydrocarbon extraction. It wants to increase it by 3 percent by 2026 by adding new foreign licenses, because the extraction in Norway is to remain at the same level. Equinor expects the demand for oil and gas to gradually start dropping across the world after 2030, which is why it wants to lower its production in the long term, i.e. in the perspective of a few decades. The decarbonization of its hydrocarbon business is to be possible thanks to the carbon capture and storage technology, as well as generation of hydrogen in the H2H Saltend project in Great Britain, where the Norwegians want to produce blue hydrogen from natural gas. Hydrogen storage may also turn out to be a new business idea for hydrocarbon companies. Salt caverns are very suitable for this. An example of this is the Advanced Clean Energy Storage project in Utah, with a planned capacity of 1 GW, designed by Mitsubishi Hitachi Power Systems and Magnum Development. The unit is to be opened in 2025. The goal is to store green hydrogen only by 2045, produced thanks to excess energy generated from renewable sources. One could imagine that in the near future, federal reserves of oil stored in salt caverns will be replaced with hydrogen, provided the transition expected by BP and questioned by Exxon will indeed happen. The fist salt cavern where hydrogen will be stored may be opened in Saxony-Anhalt, in the so called Middle German Chemical Triangle, as part of the HYPOS association. According to the estimates by the International Journal of Hydrogen Energy, salt caverns across the Old Continent are capable of storing up to 85 petawatt hours of energy in hydrogen that is produced with energy from offshore wind farms. This is enough power to cover Germany’s annual demand. Therefore, the oil and gas sector does have a window of opportunity, which could change its business model. Poland’s PGNiG’s approach is similar to that of Exxon and Equinor, as it is investing in extraction in the North Sea, but also in hydrogen storage, to which its daughter company – Gas Storage Poland is increasingly more open. In theory, the salt caverns in the Kosakowo storage could be used to store hydrogen generated from the surpluses of energy from offshore wind farms that are to be built in the Baltic. Other facilities, such as GAZ-SYSTEM’s storage unit in Damasławek could expand the scale of this business. France’s Total came up with an interesting approach. It advertises itself as a producer of “carbon neutral” LNG, because it lowered CO2 emissions in other projects, which in a way offsets the emissions generated during the production of the liquefied gas. The French boasted that they shipped their first cargo of carbon neutral liquefied gas, i.e. LNG generated with no CO2 emissions (zero net). This means, emissions generated during liquefaction of the gas were offset throughout the entire value chain, making the process climate neutral in total. The French company managed to prepare the LNG shipment this way thanks to the Verified Carbon Standards certificate, and used its projects Guyuan (wind turbines in China) and Kariba (forest protection project in Zimbabwe). In other words it combined emissions and reductions and achieved aggregate climate neutrality. Thus, the shipment that set out from the Ichthys LNG terminal in Australia and was unloaded at the Dapeng LNG terminal in China by China’s CNOOC was deemed climate neutral. Total wants to spend USD 1.5-2.2 billion on decarbonization, to make sure the carbon intensity of its products drop by 15 percent between 2015 and 2030. Exxon Mobil is also investing in, among others, biofuels and CCS.
Orlen’s and PGNiG’s strategies may meet if the companies are indeed merged. An important contribution to this topic was made by the presidential campaign in America. Joe Biden defended the idea that energy transition and the demise of oil were inevitable, but Donald Trump remained on the side of the status quo and oil and gas companies that hope there will be demand for their products. In theory Biden may adopt regulations that will help the transition, as well as loosen the sanctions on Iran and Venezuela giving them an opportunity to increase supply on the oil and gas market. Analysts asked by Energy Intel predict that if Biden pursues this policy, the oil price may drop by USD 5-10 per barrel. However, it remains to be seen whether he would succumb to the lobbying of oil companies, just like Trump who is completely submissive to them. Additionally, if Trump had won, he could stay on the course when it comes to Caracas and Tehran and continue to put pressure on OPEC+ to maintain or increase the cuts. Whereas Russians want to continue extracting hydrocarbons and pursue energy transition through removing CO2 emissions from the process, instead of abandoning the business altogether. They want to invest in blue hydrogen generated from natural gas through hydrolysis, which would be accompanied by carbon capture and storage. Such hydrogen could be successfully sold to Europe, raising concerns over the fact that without a sufficient supply and security diversification, Europe’s transition, climate neutrality ambitions and the European Green Deal would be fuelled first with natural gas, and then hydrogen from Russia. If the economic recovery is indeed driven by hydrocarbons, such an outcome may turn out to be both – good and bad for Poland. Good – because Warsaw will be able to further diversify its oil and gas imports. Bad – because such state of affairs may prolong Europe’s dependence on Russia’s energy resources. In this context, a quick energy transition that involves investments in European hydrogen sources with RES leading the way seems to make sense, because it would make the continent independent of oil and gas from Russia.
Will everybody in the oil sector be dead in the long run?
To sum up, the oil agreement may potentially allow the states that depend on oil to partially mitigate the impact of the second wave of the coronavirus on the market. However, it will not do away with the long-term impact of the hydrogen revolution, which will permanently decrease the profitability of the oil industry. The pace and the scale of its impact remain unknown are the experts are still debating on this topic. The coronavirus may accelerate the pivot from oil, unless the oil and gas sector becomes one of the drivers behind the economic recovery after the current crisis, which would be in line with the will of oil magnates from the U.S., the OPEC cartel, as well as Russia. To paraphrase John Maynard Keynes’s famous quotation – in the long run everybody in the oil sector is dead, unless it turns out that the prophecy about the demise of oil and emergence of hydrogen is a sham. Poland may win and lose in both of these scenarios.