Although cargoes of Nigerian crude are unsold on the high seas and although we very briefly saw shippers of US WTI pay to be rid of their cargoes, we are not writing an obituary for oil. Rather, we suspect that the pandemic has extended its life and that peak demand may extend beyond 2035. The cause of climate change has taken a bit of a hit. The international conference in Glasgow (UK) due this November has been deferred because of Covid-19.
The market in crude had settled at about 100 million barrels/day (mbpd) before the emergence of the pandemic. At the low point in April demand fell by about 30mpbd. As lockdowns in several jurisdictions are now eased or are about to be eased, notably in some large oil consumers such as the US and Germany, then we feel that we are off the bottom. More cars will be seen on the roads. Some traders such as Trafigura have suggested that the market could be back in deficit by the end of the summer, albeit with a huge overhang of inventory. This narrative assumes that lockdowns are not widely reinstated due to a second spike in the virus.
Alongside these positive signals on the demand side, there is plenty to report in terms of supply. According to Baker Hughes, the already low level of drilling rigs in February declined by a further 25 per cent in the following two months.
US crude production recently peaked at 13mbpd but has since started to soften. The smaller players in the Permian Basin are heavily indebted and their bankers now short of patience. Their bonds maturing in the next 18 months are trading at junk levels. As the shale industry in the US was booming, it was commonly said that their operations would breakeven at US$20-US$30/b. Now that prices have fallen through and beyond this threshold (before the makings of a modest recovery), the locals are talking of breakeven above US$45/b. The most bearish forecasts in circulation have US and Canadian production down by as much as 3mbpd by the end of this month.
This reverse for the North American shale industry was one of the objectives of Saudi and Russia when they took part in a competitive race to the bottom (for the price). The damage has been done to shale such that the state of Texas may have to start levying personal income tax.
Saudi and Russia have mercifully abandoned their race and embraced restraint once more, resulting in the accord of 12 April that introduced cuts of 9.7mbpd by OPEC+ with effect from the start of this month. The cuts will be slowly trimmed but will be supplemented hopefully by restraint from non-members such as Norway.
Looking a little ahead, we have to mention electric vehicles. Outside the US they remain a luxury product, and in most developing countries they have rarity value. Electric aircraft seem some way off. We have to acknowledge, however, that international air travel will not return to last year’s levels before 2022 at the earliest in the view of British Airways, which was explaining its job cuts of about one quarter of its global workforce.
A second threat to the oil industry that has been overstated in our opinion is a putative investment strike by institutional shareholders. Chevron has dropped its share buybacks, and Exxon has cut US$10bn of capital spending to protect dividend payments. True, the majors have plans to reduce or end emissions, and programmes for renewables but these are small relative to their commitments to fossil fuels. They like to pay generous dividends alongside the miners and banks, and thereby cement shareholder loyalty. In Q1 2020 for example, BP maintained its payment and Shell reluctantly made its first cut in 80 years.
To paraphrase Mark Twain, who may have been misquoted in the first place, reports of the death of the oil industry have been greatly exaggerated.
Head, Macroeconomics and Fixed Income Research, FBNQuest