It is plain that the coronavirus pandemic has substantially curtailed demand. What is not made clear in the complaint is that the recent demand shock from the economic fallout over the virus compounded an already existing long-standing oversupplied market. It is also plain that the current price war between Saudi Arabia and Russia flows from a deterioration in political cohesion over the historical governing structures of the energy industry, which have been led for the most part by the Organization of Petroleum Exporting Countries (OPEC).
The cumulative impact of these two factors, when combined with the rise of production in the United States from unconventional oil and gas drilling (“fracking”), have been leading causes of a decline in oil and gas prices. Other broader causes related to the changing structure of demand for oil and gas has also influenced the deterioration of the industry.
None of these factors are of recent origin. The current precipitating events of the coronavirus and the conflict between Russia and Saudi Arabia simply bring these festering problems into sharp relief.
• As summary evidence of the long-term nature of the energy sector’s problems, the RRC should consider that the oil and gas sector comprised 28% of the Standard & Poor’s Index in the 1980s. As of March 31, 2020, the oil and gas sector makes up only 2.6% of the S&P Index.
• As summary evidence of the long-term nature of the energy sector’s problems, the RRC should consider that for the last ten years the energy sector has underperformed the stock market. For many years prior, the energy sector led the world market. In 2018 and 2019 the energy sector placed last among all sectors indexed in the S&P 500 and it is likely that this will continue to be the case in 2020.
• The role of fracking in creating an oversupply of oil and gas in the United States over the last decade is well known. The inability of unconventional producers to establish a successful business model is also well known. The retreat by institutional investors from the fracking sector is well recognized.
• The oversupply issue is most visible as the industry continues to flare increasing amounts of gas that, although extracted, has no economic value.
• The political consensus that once ruled the industry is increasingly fragmented. The declining significance of OPEC as the focal point for market rationalization reflects the deterioration in its members’ collective market share and the rise of the role of the U.S. and Russia in the market.
• The changing composition of GDP growth from economies that are heavily reliant on fossil fuels to those less reliant on fossil fuels is apparent.
• The serious decline in oil prices from the mid-$50s/barrel to below $20/barrel represents a drop from an already low price to a very low price. Most oil and gas companies, recovering from the price collapse of 2016, have responded by introducing greater efficiencies and driving down production costs. Many now contend they can accept lower prices – in the $60/barrel range – for longer. Most oil and gas companies, however, have not demonstrated that prices in this range can improve balance sheets and raise investor confidence. The sector remains an underperformer in the stock market.
One conclusion from these trends is that the economy is now capable of financial growth even if the fossil fuel sector is not growing.