Crude oil and natural gas prices fell significantly over the past four months. As widely reported, the fall was driven by a certain supply and demand interface arising principally, from the current Coronavirus (Covid-19) pandemic, but compounded by a keen duel for market share by major oil producers.

Oil prices have rebounded somewhat, to US$40.50 per barrel (Brent) and US$38.00 per barrel (WTI) as at 16:00 hrs on 26 June 2020; about 60% (Brent) and 63% (WTI) of January's average values. For the WTI, it was a substantial recovery from the dismal value of -US$36.98 per barrel recorded on 20 April, just over two months ago.

However, even with that rebound, the markets’ trajectories may remain uncertain.

Covid-19 And The Global Economy

Economies around the world have sustained brutal impacts from the current Covid-19 pandemic. The U.S. National Bureau of Economic Research which dates recessions has announced that the country officially entered recession in February of this year, ending the 128-month expansion that began in June 2009. The U.K. suffered a 20.4 per cent month-on-month GDP decline in April, according to the Office for National Statistics, ONS.

The Organization for Economic Cooperation and Development (OECD), in its recent Economic Outlook stated that the economic impact of the pandemic would be protracted and harsh. It projected a 6.0 percent decline in the global economic output for 2020 and a growth of 5.2 percent in 2021. However, in a second-wave pandemic scenario, it projected a 7.6 per cent decline for 2020 and a growth of only 2.8 per cent in 2021.

Countries around the world are gradually emerging, albeit at different rates, from the lockdown imposed as one of the curtailment measures against Covid-19. As business activities have increased, oil prices have also ticked up, driven in the main, by increased demand for petroleum products, especially gasoline.

That relaxation of lockdown however, has come with spikes in cases of Covid-19 infection. In the U.S., that spike was 25% for the week ended June 21 compared to the previous seven days, Reuters reports. At least 25 states including Florida, Arizona, Texas and California recently recorded significant increases in the number of cases; for some of them, the spikes included the highest single-day values since the pandemic.

Already, Seoul (South Korea) and Beijing (China), just a few days ago, announced second waves of the Covid-19 pandemic; and the tech company Apple has announced closure of some retail outlets in the U.S. due to the spike in Covid-19 cases. In addition, there are media reports that the European Union is considering banning travelers from the U.S. due to that significant spike in infection cases.

The concern then, is that an increase in infection cases (a second wave) may lead to further lockdowns, a decrease in economic activity that would impact oil and gas prices. Most of the cases have been attributed to failure to adhere to safety recommendations adduced by the relevant health authorities.

In the absence, therefore, of a vaccine for the virus — which may take as long as 12 months to develop, test and approve — that concern and uncertainty may endure.

Fundamentals

Monthly crude oil demand for 1H 2020 dipped significantly compared to year-ago levels. Rystad Energy’s recent estimates project a fall in oil demand of 11.7 million barrels per day (MMbpd) from the previous year’s level. About a billion barrels were “quarantined” in floating, underground and other storages due to that demand destruction occasioned by the pandemic.

The increase in crude oil prices over the past few days, including a backwardation — a situation where prices for immediate delivery are at a premium to that of the future — had raised expectations for a rapid and sustained oil price rebound. That expectation however has been tempered by near-term factors.

U.S. weekly oil stocks rose steadily from 08 May through 19 June, even as oil prices increased, adding to oversupply concerns and implying that the price increases may not be reflective of actual fundamentals. In addition, the Saudi government has banned foreign pilgrims from this year’s Hajj pilgrimage in Mecca. Last year, 1.75 million pilgrims came from abroad to perform the Hajj, including 96,000 by road, Argus reports. The spike in demand for gasoline and aviation fuel which that event triggers will most probably, not be seen this year.

Driven by drilling efficiencies, U.S. oil and gas production — particularly from shale formations — helped propel the country to output records in 2019. According to U.S. Energy Information Administration, EIA, crude oil and natural gas production for that year reached 12.2 MMbpd and 111.5 billion cubic feet per day (Bcfd) respectively, even with the lowest rig count since 1975. This contributed to the subsequent global supply overhang. While natural gas has seen a global supply overhang, it is set to benefit from shut-ins in the North American oilfields, which account for about half of global associated gas output.

The U.S. shale industry is facing significant headwinds and which the current pandemic is only compounding. Typically, decline rates for shale oil output is as high as 65% for the first year alone, compared to 8 – 10% over the first few years for conventional oil fields. This requires continuous drilling just to maintain output and that comes with cost implications. Having sustained massive losses in the earlier oil price collapse, financial institutions have been reluctant to fund operations and investors are demanding greater returns.

The U.S. shale industry could be forced to write down about US$300 billion of their assets this year, increasing the sector’s leverage to 54% from the current 40%, Financial Times reports. That write down assessment was based on an oil price of US$35 per barrel. While operations at the “sweet” parts of the prolific Permian Basin may breakeven at that price, most of the U.S. shale operations would not. The average monthly oil (WTI) price in the last four months to May, was US$31.22 per barrel. If the impact of the current pandemic is sustained, the sector could witness insolvencies and consolidations; for the latter, oil majors would most probably be the only capable players.

Investments And Impairments

Capital projects have also been affected by the Covid-19 pandemic. In order to preserve cash and maintain shareholder payouts, many capital projects have either been delayed or cancelled outrightly. According to GlobalData, as at April this year, more than US$85 billion of 2020 forecast expenditure by more than 100 companies has been excised.

Global upstream investment for the current year is projected to plunge 29% to a 15-year low, according to consultants Rystad Energy, and the world’s recoverable oil volume could fall by 282 billion barrels. While this may hold implications for future oil supply, energy transition issues may also weigh in.

If the current low-price regime for oil is sustained, aging and underperforming oil and gas assets around the world especially in the North Sea, as well as parts of Gulf of Mexico and offshore Brazil, could be forced into retirement. With substantial plugging and abandonment costs, it is unlikely that small-to-medium size operators would be capable of taking over these assets. World Oil reports that worldwide, it would cost an estimated US$104.5 billion by 2030. Future capital expenditure by operators of such platforms would certainly be viewed in the light of these costs.

Foreign Policy

Oil and gas markets are, as almost all others, driven by various state policies. OPEC+, a group comprising members of Organization of the Petroleum Exporting Countries (OPEC) and its collaborators, in an agreement which lasts through July, was responsible for curtailing the massive global oil supply overhang brought about by the pandemic by almost 10%. This helped double May Brent prices from earlier-month levels. 

While compliance with that agreement stood at 85% in May according to Platts, future compliance and its enforcement remain uncertain. Nigeria and Iraq exceeded their output quotas last month and are still in the process of remediation. It is also uncertain, in the light of divergent interests, if an extension to the production cuts — which could still be necessary — can be agreed. Traders and analysts will be watching with keen interest.

The current tense relationship between the U.S. and China — the world’s largest and second-largest economies respectively — is a point of interest for the world at large. A few days ago, the markets were rattled when one of the U.S. president’s aides announced that the country’s trade deal with China was over; though the president contradicted that just a few hours later, the relationship has remained tense.

Canada, Mexico and European countries may be preparing reprisals to a plan by the U.S. to impose tariffs on some of the countries’ goods. A global trade war at this time may compound the current economic downturn and further delay a rebound which will inevitably affect oil and gas market fundamentals.