Post pandemic, just how crude will oil’s future be?

Climate Economy

Post pandemic, just how crude will oil’s future be?

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COVID-19 devastated the oil market, but it was just a taste of what is in store for the industry.

BY BILL SPINDLE AND MILO MCBRIDE

For the global oil industry, the COVID crisis offered a crystal ball-like peek into its future. The view wasn’t pretty.  

Demand for oil, which has marched relentlessly higher for a century, suddenly plummeted to unprecedented lows.

Had the problem been the global pandemic alone, the industry would almost certainly have put on its usual brave face. Oil titans are, if nothing else, expert managers of travail — whether wars, embargos, environmental mishaps, natural disasters or political upheaval.

But it was more than that. The Covid outbreak came amid an epochal transition away from fossil fuels, and it looked less like industry’s newest challenge to conquer than a vision of the future, a vision of relentlessly falling demand for oil and gas. 

Oil majors, consultants and multilateral institutions now agree that “peak oil” is just over the horizon. British oil major BP recently laid out two scenarios, one where demand has already peaked and the other with the peak coming in 2025. Consultants Rystad Energy recently echoed this time frame while McKinsey & Co. and Norway’s state energy powerhouse Equinor ASA, are among those predicting a peak by the end of the decade. The Organization of the Petroleum Exporting Countries (OPEC) argues — and most certainly holds out hope — for a considerably longer timeline, but even they are conceding it will come by 2040.  

Pandemic plunge

As energy consumption collapsed with pandemic lockdowns, an economic knife fight broke out between the two biggest petro-states, Saudi Arabia and Russia. Since late 2016, they had been working relatively well together, managing supply for a world demanding around 100 million barrels of oil per day. But when demand plummeted, a dispute broke out over who should withhold how much production from the market to prop up prices. Saudi vowed to unleash a flood of new production onto a market already awash in unwanted oil.

The result was a stomach-churning drop to sub-zero prices as storage tanks filled with oil and futures traders actually paid to get rid of impending shipments. Leaders of the two countries patched up their differences sufficiently to carry on.

But while state oil powerhouses can absorb the short-term stress of such low prices, their publicly traded competitors spiraled into acute financial distress, particularly those in the U.S.-based fracking industry. These upstarts, who extract oil and gas from solid rock, expanded rapidly in the past decade to make the U.S. the world’s largest oil producer. Now, as they frantically laid off workers and cut spending on new wells, some frackers went bankrupt. Those remaining have refocused on their investors, who had grown impatient with paltry returns even amid record-breaking production gains. 

The fracking industry won’t grow at all this year, said Ryan Lance, Chairman and CEO of ConocoPhillips, speaking to an industry conference CERAWeek by IHS Markit in March. Producers are “hyper-focused” on assuring investor returns, not just expanding production, he said.

A return to normal? 

In the short run, recovery for the oil industry remains dependent on the global rollout of vaccines and government stimulus spending. Indeed, oil consumption has been ticking up in the first quarter of 2021, and the US Energy Information Agency (EIA) sees consumption in larger volumes than 2019 as early as next year.

Yet the International Energy Agency (IEA) notes that “there may be no return to ‘normal’ for the oil market in the post-COVID era.” 

European oil majors BP, Shell and Total have emerged from the crisis flat-out pronouncing oil will be their past, and green energy their future — though the timeline they have laid out for this transition suggests a lack of urgency. 

U.S. majors Chevron and ExxonMobil most definitely did not embrace the notion of an oil-free world, at least not in the foreseeable future. Michael Wirth, chairman and CEO of Chevron told the CERAWeek audience the oil market’s decline of “only” 9% during a global economic crisis of this magnitude is evidence of “just how essential it is to everyday life.” 

ExxonMobil slashed the value of its reserves and sharply cut back on new exploration. 

That’s an acknowledgment that the company’s — and the industry’s — horizons are narrowing, especially for the integrated oil companies, giants of the global oil patch. In a market doomed to decades of falling demand, petro-states like Saudi and Russia will hesitate to prop prices up by withholding supply. Why? They increasingly understand that propping up prices by withholding oil risks stranding barrels in the ground — forever unsold.

The 40 countries most dependent on oil and gas production stand to lose more than half of their revenues from those sources by 2040 in a low-carbon scenario for the world, according to a recent report by Carbon Tracker. That would be a whopping $9 trillion hit. 

The Arab Gulf states, which have talked for decades about diversifying their economies, are stepping up to this politically risky task like never before. They will need every dollar of near-term revenue from oil sales to accomplish the task. 

Electric vehicles are verging on mainstream acceptance, threatening to replace oil’s largest source of demand. Automakers are rushing to set target dates for entirely electric vehicle production. For Volvo it’s 2030, General Motors says 2035, and for Daimler Chrysler it’s 2039. Bloomberg New Energy Finance estimates that by the last of those dates the EV market may even surpass that of petroleum-fueled automobiles. China’s auto market, the largest in the world, already accounts for 41% of global EV sales.

Climate targets 

Although markets are shifting, the eventual decline in oil production is unlikely to meet current climate goals. The overarching question remains: Just how much more oil combustion can our planet take?

According to a 2015 study published in Nature, “[A] third of oil reserves, half of gas reserves and over 80 percent of current coal reserves should remain unused from 2010 to 2050 in order to meet the target of 2°C.” 

Taking that as a guide, our back-of-the-envelope calculations indicate global oil demand must fall an average of 3% per year, following the COP26 summit in Glasgow this November. 

That would leave global oil production at around 55 million barrels a day by 2040 — less than half the production levels projected in 2021. Even that could prove wholly inadequate. Afterall, the Paris Accord guiding the upcoming U.N. climate summit late this year in Glasgow includes the more ambitious goal of limiting global warming to 1.5 degrees.

Furthermore, that 55 million barrels we calculated is nearly 20 million barrels a day less than the most aggressive, and thus most difficult, decarbonization scenario outlined by the IEA

By any measure, it clearly will take far more than a global pandemic to turn the carbon-fueled economy around. In a “dire warning” from IEA executive director Fatih Birol, the agency projects global emissions will rise by 1.5 billion tonnes in 2021 — the largest spike in over a decade. 

All Eyes on COP26: The United States of America

With the drastic growth of the American fracking revolution, the United States reclaimed its long-lost position as the world’s hydrocarbon superpower. In just a decade, the U.S. has become far and away the largest producer and exporter of oil in the world — an achievement that President Trump touted as “energy dominance.”

However, President Biden is pursuing bold climate and energy policies that promise to take the country in a very different direction. Alongside an immediate return to the Paris Agreement, the Biden administration has released an updated, exceptionally ambitious plan to reduce emissions in half (relative to 2005 levels) by the end of the decade — a critical piece in invigorating international deliberations in Glasgow this November.

The announcement comes as John Kerry, Biden’s “Climate Tzar,” meets with world leaders to try to heal the diplomatic wounds inflicted during Trump-era climate politics. Kerry has described the upcoming COP26 summit as “the last, best opportunity that we have and the best hope that the world will come together to build on Paris.” 

Unlike its fiercest petro-producing competitors — Saudi Arabia and Russia — the U.S. government does not control the country’s oil majors. But it does have powerful levers at its disposal, namely, tax and subsidy reform.

A recent policy report from the U.S. Treasury claimed that “the President’s tax plan would remove subsidies for fossil fuel companies, while providing incentives to reposition the United States as a global leader in clean energy.” 

The Treasury estimates that eliminating fossil fuel subsidies would increase tax receipts by an estimated $35 billion over the next decade. Figures from Oil Change International, which are echoed by progressive Democrats, suggest federal subsidies are actually worth $15 billion annually — far more than the Treasury figure. 

Just how much of that Biden’s knife will be able to reach remains unclear. The executive branch has no jurisdiction to regulate state subsidies, which in places like Texas, Oklahoma and Louisiana have been bountiful. Some estimates put state subsidies at around $5 billion annually. The president can, however, bring about cuts to direct subsidies that support projects like overseas drilling projects — sometimes amounting to billions worth of loans, according to the Organization for Economic Cooperation and Development.

The most generous fossil fuel handouts come in the form of tax loopholes. Notably, the “Intangible Drilling Cost Deduction” and the “Percentage Depletion Cost Allowance,” which allow oil and gas firms to write off drilling expenses and depreciation costs. Removing them could throw much of the industry’s viability into question.

Loopholes like these have been ingrained into U.S. law for nearly a century, and for almost as long, Democratic politicians from Franklin D. Roosevelt to Barack Obama have occasionally tried to reform them. Will President Biden be the one to succeed?

Whether the U.S. can begin winding down its relentless production of oil will be critical in determining whether Glasgow is more talk or spurs genuine action. 

Written by

Bill Spindle

Bill Spindle is a freelance journalist who has reported from more than 30 countries. He worked for The Wall Street Journal for two decades as bureau chief for South Asia and the Middle East, and as a correspondent in Japan. He also covered global energy and climate issues including the Paris climate conference, the fracking industry and OPEC, and the rise of renewable energy sources.