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IEEFA update: Rebound from collapsed oil prices will be low and slow

March 09, 2020
Tom Sanzillo and Melissa Brown and Tim Buckley

If there were questions about what volatility in a low-priced oil market looks like, on Sunday, an iconic example was on full display.

When the markets opened, oil traded in the $30/barrel range—a whopping 20 percent decline from the previous Friday. The fall was triggered by Russia and Saudi Arabia, which both promised to boost global oil supplies. Those announcements had multiple intents, including disciplining the U.S. shale industry, boosting Chinese imports, shaping global oil markets—and, possibly, punishing each other. The disorder and conflict that preceded these announcements, and the market chaos that ensued, clearly demonstrated that no one institution is in control of the oil markets.

The new price volatility brings some key market trends to the foreground, all of which bear watching:

  • The integrated Chinese oil majors will pay the price for national service. Low prices hit state-owned oil companies hard, including their diversified oil, gas, and petrochemical interests. But in this downturn, the typical boost from low prices may be muted, as broader economic decline tamps down robust demand for energy or petrochemical products. China’s rush to build out its gas infrastructure to move high cost imported gas will lose momentum. Even PetroChina is looking to offload its loss-making pipeline assets. China’s energy planners may want to take a hard look at how to get leverage out of the new high-voltage power grid assets they have built to move more renewable power. An accelerated shift toward electrification could lock in the potential of lower cost renewable sources.
  • The energy sector’s strategies are in disarray. Subsidies are now at war with economic fundamentals. Watch the fallout as markets unravel affecting the various subsidies and oil and gas cross-pollination schemes in Canada, Argentina, and between and within companies; industry-sponsored carbon innovation schemes around the world; and new technologies to boost production, from drill bit designs, to geological wizardry, to applications of IT. All must be rethought as claims about marginal productivity growth give way to more fundamental and dramatic deterioration in the investment rationale for fossil fuel investments.
  • The economic risks of fossil fuel lock-in have just exploded. Asia’s energy growth markets have long been told to bulk up on high cost fossil fuels rather than build lean and nimble grids that can scale in alignment with advances in deflationary new power technologies. The volatility of the past three days has destroyed what used to pass for conventional wisdom. The high-cost infrastructure needed to service fossil fuel imports —grids, ports, gasification terminals, rails, and pipelines—takes decades to pay off. These investments make no sense when fuel price volatility can whipsaw markets and wreck even the biggest energy companies. By contrast, renewables can insulate Asia’s high-growth economies from fossil fuel price volatility.
  • The oil majors’ capital budgets are now up in the air. ExxonMobil, for example, just announced a new round of capital spending of up to US$35 bn annually that has been rendered obsolete almost overnight. Did the company learn anything from the last downturn? A doubling of oil prices since 2016 did nothing to improve the financial fundamentals of investing to develop high cost reserves. This aggravated chronic oversupply at a time when major markets are all benefiting as increasingly competitive alternatives reshape energy and power markets.
  • Market instability will undermine the economic chain that supports petrochemical and plastics production. Even with lower cost feedstocks, a slowdown in demand coupled with lower prices for plastics creates economic uncertainty. Will the price disruption slow down capital spending on new cracker plants and plastics manufacturing? Will some companies put their development plans on hold, or cancel them outright?
  • Political risks in the oil markets have multiplied. Just when it seemed impossible for the political fragmentation within energy-producing nations to get any worse, it did.

The broader market signals are pointing away from fossil fuels and toward renewables and other fossil fuel replacement strategies. These signals should make it clear that, even if oil prices eventually recover some lost ground, the next growth area is not in the fossil fuel sector.

Yes, fossil fuel interests will continue their talk of an “if only” rebound: if only the flu would go away, if only interest rates would stabilize, if only oil and gas prices would rise, if only climate and environmental regulations would disappear, if only U.S. shale producers would become disciplined.

Yet in truth, fossil fuel development is too expensive for this economic epoch.

The industry cannot thrive at $55 per barrel, much less $35 per barrel

Even fossil fuel proponents seem to agree that nobody—not the Saudis, nor the entire OPEC crew, nor Russia nor the U.S. shale industry—has the power to control oil prices. We may even see some new organizational forms emerge in the oil sector, attempting to bring some cohesion to policy and production decisions.  The result would likely be an agreement to raise prices, but such an outcome would only spur consumer nations, business and households to press even harder for alternatives to fossil fuels.

WE CAN EXPECT FOSSIL FUEL COMPANIES TO DOWNPLAY THE SIGNIFICANCE OF THE WEEKEND’S PRICE COLLAPSE, arguing that prices will have to stay low for a long time to cause damage to the U.S. economy and global markets. But this completely misses the last five years—a period when oil prices rose to the $50-70 range, yet large segments of the energy sector sank into financial disarray. There is scant evidence that the industry can thrive at $55 per barrel, much less $35 per barrel, when big players like ENI have pegged US$45/bbl as the break-even for their new five-year capex plans.

Collapsing stock prices attest to market wariness about the new price regime. Low oil prices will also trigger job losses in the energy sector—look at Alberta, Canada as a harbinger. And even the most bullish companies will ultimately fall in line with the trend toward decreased capex spending.

The plea that price increases will solve the industry problem also misses the fact that that there are new markets in the energy and transport sectors that every day are finding both supply-side and demand-side innovations to diminish the market’s captivity to fossil fuels. These alternatives offer cheap, stable and efficient alternatives to the roller coaster ride of fossil fuel markets.

The energy sector was down well before the coronavirus. This is the third year, now going on the fourth, that energy stocks have been the market’s worst performers.  Last place is a clear statement of the energy sector’s loss of financial performance, technological acumen and political leadership—and a sign that oil and gas is a sector better suited for another time and another place. Today was a reminder that markets look forward, and are unforgiving to Luddites who fail the leadership test.

Tom Sanzillo is IEEFA’s director of finance.
Melissa Brown is IEEFA’s director of energy finance studies, Asia.
Tim Buckley is IEEFA’s director, energy finance studies Australia/South Asia.



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Tom Sanzillo

Tom Sanzillo is Director of Financial Analysis for IEEFA. He has produced influential studies on the oil, gas, petrochemical and coal sectors in the U.S. and internationally, including company and credit analyses, facility development, oil and gas reserves, stock and commodity market analysis, and public and private financial structures. He also examines such areas as community and shareholder activism, institutional investment, public subsidies and Puerto Rico’s energy economics.

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Melissa Brown

Former Director, Energy Finance Studies, Asia, Melissa Brown, a former securities analyst at JP Morgan and Citigroup, has played a leading role in various Asian investment organizations focused on mainstream and sustainable investment strategies for public and private equity investors over the past 25 years.

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Tim Buckley

Tim Buckley, Director, Climate Energy Finance (CEF) has 30 years of financial market experience covering the Australian, Asian and global equity markets from both a buy and sell side perspective. Tim was formerly Director Energy Finance Studies, Australia/South Asia, IEEFA, and was a Managing Director, Head of Equity Research at Citigroup for 17 years until 2008.

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