Ever since the days of former chief executive John Browne, BP has had a talent for making headlines and leading the industry, if not always in the right direction. Its latest energy outlook, the first major long-term view that takes the coronavirus into account, shows the potential for an imminent peak in oil demand.
Rather than some abstract exercise, such a near-term peak has major implications for the choices of companies and of OPEC.
BP presents three scenarios for global energy and climate: one assuming “businesses as usual” gradual evolution of business and policies, and two consistent with the Paris Agreement targets of limiting global warming to 1.5 to 2 ˚C. However, in every one scenario 2019 appears the all-time peak of oil demand.
Even with business as usual, demand recovers only slightly to 2025 before falling gradually. In the other two cases, oil demand drops precipitously to 30 million to 50 million bpd (barrels per day) by 2050. That may seem a long way off, but is well within the active life of oilfields developed today.
The scenarios are given more credibility by being in line with BP’s own new corporate strategy. This involves its oil and gas output falling about 40% by 2030 and not entering any new countries for hydrocarbon exploration why building up its portfolio of solar, wind and electric vehicle charging stations.
Despite some claims, BP is not the first major oil company to predict an imminent peak in oil demand. Statoil (now Equinor) has for some years had scenarios that peaked between 2025-2030. Even BP last year provided a scenario with a peak around 2024. It is only natural that the severe demand destruction of Covid-19 would bring that date forward.
Additionally, all the major European oil companies have targets for net zero carbon emissions by 2050 and BP’s is not the most aggressive.
Such Scenarios depend on the post – Covid change in habits such as more home working and the dismal effect of climate change on economies.
Non-oil technologies may be boosted by a rapid environmental conversion by the governments of leading countries and the removal of policy barriers. A part from renewables and electric cars, now quite mainstream, sectors such as plastics, shipping and aviation will have to source non-oil alternatives quickly.
European petrol demand is certainly under strong pressure. The European Green Deal, part of post-pandemic recovery, will strongly emphasize electric vehicles. Refining and margins in shrinking markets, such as Europe and Japan, would also fall. In 1967, there were 40,000 petrol stations in the UK – today there are about 8,000 for a car fleet three times larger. Charging points at home and work could eliminate many remaining forecourts. The near – term path for the US depends on the results of November’s election. But in the longer term, public opinion in the more economically dynamic parts of the country, and the requirements of sustainability minded investors, will drive companies to turn to zero-carbon options.
The big question mark is in developing Asian economies. India, China, Indonesia and others have not weaned themselves off coal, which is dirty but cheap and secure. Even the growing competitiveness of renewables has not yet made much impact on the portfolio of planned new coal power stations, despite analyses showing solar and wind would be cheaper.
This situation may well be repeated for familiar and convenient oil-fueled vehicles. Beyond China, where the government has strongly backed them, EVs will need to be clearly superior in cost and performance, and should appeal to consumer tastes.
Since the global financial crisis, oil demand has grown on average almost 1.4 million barrels per day each year, ranging from 0.8 million to 1 million barrels per day when oil prices were high to 1.8 million bpd when they had just fallen sharply in 2015-2016.
Opec expects demand at about 90.2 million bpd this year and 96.9 million bpd next year, recovering to 2019 levels of 2022.
This all depends on a rapid easing of the Covid-19 pandemic and the associated economic fallout. After the 2008-2009 global financial crisis, in retrospect a less severe shock, demand rose 3 million bpd in 2010. A resumption of the past decade’s average growth from 2022 onwards would get us past the 2019 level by about 2024. So even BP’s business-as-usual scenario requires a sharp break with past trends.
For oil companies and oil-exporting countries, the exact timing of the peak may have attracted much debate. But it is less important than the level of demand at peak, the speed of the decline afterwards and the price path. It would be easy to adjust to a long, bumpy plateau of demand than a rapid decline.
Prices will probably be lower on average as demand drops. But there will in our opinion still be cycles of under-investment and inadequate capacity when the market tightens.
Geopolitical events, perhaps the failure of the industry in collapsing states such as Venezuela and Libya, could also interrupt supply. Investment in some non-opec producers may be constrained by a loss of investor appetite.
Because of these factors, BP expects opec to gain market share. But its overall production is set to drop in the decade to 2030, then rise only gradually to 2050. National oil companies and ministries, which have planned for major production increases and for vast new refineries to meet Asian appetites, will hope BP is mistaken.
In the US, it is less than three months since Donald Trump travelled to Texas to declare that the US energy industry, laid low by this year’s oil price crash, was back on its feet.
But bankruptcy numbers released last month tell us a different story. Another 16 upstream US oil and gas companies – producers and service providers – hit the wall in August, the same number as in July, according to law firm Haynes and Boone. Bigger drillers such as Chaparral and Valaris have joined a pile-up that has seen companies with a combined 85 billion dollar worth of debt file for protection from creditors over the past eight months.
We at Calvin•Farel believe that we’re continuing to see a steady stream of oil and gas producer bankruptcies and oilfield service bankruptcies. And we do not anticipate any immediate interruption in that steady stream, especially on the oilfield service side.
If oil prices stay around current levels – with US marker West Texas Intermediate trading in the region of 40 dollar a barrel – the number of operators expected to file for chapter 11 by the end of 2022 could hit almost 190, according to Rystad Energy, a consultancy.
That would be on a par with the total number of casualties over the five years to 2019.
The country’s oil sector was battered in the early months of the coronavirus pandemic, which sapped global consumption by as much as a third, just as a surge in Saudi Arabian output left the market oversupplied. Prices collapsed, with the US benchmark turning negative in April for the first time ever.
That left US producers slashing production as they scrambled to cut costs. For the services groups that provide producers with muscle and knowhow, it was even worse: work dried up to a trickle.
Prices have since recovered some ground but the industry is still hurting. It’s a downward spiral in our opinion.
The oil industry is no stranger to downturns. This time, however, debtholders’ losses in our opinion could be serious. Rating agency Moody’s reckons investors’ recoveries on defaulted debt will be somewhere between the levels of 2015 (21%) and 2016 (50%). That is much lower than the historic average of 58% since 1987. Currently the lack of capital is problematic – the lack of investor interest is problematic – and the excess amount of distressed assets is problematic. That’s why we expect more below-normal recoveries in this cycle.
And as companies come through the other side of bankruptcies, they will be emerging into a different world. Much has changed – and they are going to have a tougher time accessing capital. In our opinion investors aren’t willing to take the same risks as before because the outlook has changed.
Five years ago, the market was expecting higher oil prices and strong mergers and acquisition activity, while environmental, social and governance considerations were a “European focus”. Today that’s changed. Prices are lower, M&A is dead and ESG is here. Many investors – burnt by defaults in the previous downturn – are fed up with the sector. From credit investors and banks to equity investors, there is a reluctance to throw good money after bad.
One thing most investors agree on is that the sector is desperately in need of consolidation. But currently there is little appetite to do that until companies can clean up their balance sheets-which means allowing the bankruptcy wave to run its course.
And with little confidence in asset valuations, only Chevron has so far made a significant deal with its agreement to buy Noble Energy.
This year’s price crash was the worst in decades. Despite the US president’s desire to draw a line under it, the sector in our opinion will be reeling for some time.
“People were very concerned about that industry,” Mr. Trump said in late July, recalling the panic of a few months earlier. Looking ahead, they still are.
