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Energy 31 March, 2020 10:00 am   

Coronavirus killed the oil agreement. An opportunity and a challenge for Poland (ANALYSIS)

The oil price war will continue because the oil agreement has lost its power in view of the expected drop in demand caused by the coronavirus pandemic. This creates an opportunity for Poland to make itself independent of oil from Russia, but it also poses a challenge to the country’s refineries – writes Wojciech Jakóbik editor-in-chief at BiznesAlert.pl.

Coronavirus killed the oil agreement

The Brent oil price per barrel dropped below USD 25 continuing its downward spiral caused by the collapse of the oil agreement and the coronavirus pandemic. The deal to limit oil production will expire at the end of March. The drop in oil prices is exacerbated by the plummeting demand, caused by limited economic activity. According to estimates by Fatih Birol, head of the International Energy Agency, the demand decreased by 15-20 million barrels a day, which is 20% less than last year. The decline is caused by the coronavirus pandemic, which has already infected half a million people and caused 32 thousand deaths across the world. It has also forced countries to limit  their economic activities, including shutting down civilian flights, which resulted in lower demand for jet fuel. According to Goldman Sachs, the demand for oil will drop by 10.5 m barrels in March and 18.7 m barrels a day in April. The year on year drop in 2020 will be 4.2 m barrels a day.

I have already written about the war of attrition between Saudi Arabia and Russia. Until recently the International Energy Agency has estimated that the drop in demand will amount to 90 thousand barrels a day in 2020. Rystad Energy is projecting a 4.9 m drop a day. However, further depreciation of the price may cause a demand depression to the tune of the already-mentioned 15-20 million barrels a day (20 percent). When the pandemic reached its peak in China last January, oil demand decreased by 3 m barrels a day, i.e. by 1/5, which means the projections correspond with what happened in Beijing.

Meanwhile in Europe one of the drivers behind lower demand, may be the decreased demand for electricity caused by the restrictions introduced due to the coronavirus. The week before March 30th, the Breugel think tank recorded that the power demand in Italy, whose economy has been impacted the most by the virus, dropped by 26% and in Poland, where the restrictions are not as severe, by 10%. If the security measures are increased, this trend may grow and cause a drop in demand for other raw materials, including oil.

According to S&P, daily oil supply will drop by 2.3 million barrels in 2020. IHS Markit believes there will be an oversupply of 1.8 m barrels a day in the first half of 2020. However, if the demand drops by 15-20 m barrels a day, the reduction of supply may increase. Western producers are already cutting extraction plans and the number of working oil wells in the US is going down. The states engaged in the collapsing oil agreement that are currently waging a price war, i.e. Saudi Arabia and Russia, may also be forced to limit production. The 30% drop in gas demand in Germany has already forced Gazprom to alter its plans. Lower oil demand may force Russian companies, such as Rosneft, to change their plans as well. This means the oil deal, even if not extended formally, will in reality be implemented with a surplus. Its latest version said the production should be lowered by 1.7 barrels a day, but the producers may be forced to implement more severe reductions because of the coronavirus. Despite calls from Algeria, which currently holds the OPEC presidency, to revise the cartel’s production plans, the members did not agree to hold an emergency meeting. OPEC+ has already lost its impact on the oil market, which will have to face a period of oversupply, slowly abetted by investment cuts made by oil companies, a decision which would not be signed by the producers today.

Perhaps this is why Saudi Arabia is still refusing to hold talks on ending the price war, even though this has been suggested by Russians and… Americans. The US State Department has decided to issue an unusual appeal to Riyadh asking it to impact the oil market. Despite that there is no way Americans could join the oil agreement. “Energy ministers of Saudi Arabia and Russia have not talked about inviting new members to the OPEC+ group, nor have they discussed a joint agreement that would balance the oil market,” a representative of the Saudis told Reuters. Only cuts that would be deeper than the forecasted dropping production year on year (over 4 m barrels a day), or including the USA in the agreement, could result in a temporary increase in oil prices. However, this doesn’t mean a further drop in oil prices caused by the ongoing economic slowdown would be prevented.

An opportunity and a challenge for Poland

All of this creates an opportunity for Poland’s PKN Orlen and Grupa Lotos and others to receive rebates from Saudi Arabia and Russia. This could happen if long-term contracts are renegotiated, or if the Polish companies limit the implementation of said contracts to the minimum and look for opportunities on the exchange. Moreover, this is also an opportunity to speed up diversification and lower our dependence on heavy crude from high-risk countries like Russia, Iran and Venezuela and replace it with light crude from the US and Saudi Arabia.

At the same time this is bad news for refineries. In India, LNG traders have already made use of the force majeure provision in contracts because of the restrictions on people’s personal movement, and refineries followed suit. It is probable these types of companies will cut their output by 15-20%, lowering their revenue, because they will not be able to sell oil products. This is caused by the lack of storage capacity, which is already full at three quarters and quickly dwindling. In March Rystad Energy has reported that the available storage capacity is 1.7 billion barrels out of the 7.7 bn total. The company has also estimated that in the second quarter of 2020 the demand for storage will be at 15 m barrels a day, or 1.3 billion barrels if the biggest consumers, such as India, introduce restrictions on personal movement.

This means that the benefits of lower oil prices and new diversification options for oil importers like Poland will be accompanied by challenges, such as the need to limit oil production and processing  by Polish companies. Western European companies, e.g. France’s Total, have already announced cuts.