Scale of oil demand collapse is beyond what industry can handle, says IEA

The scale of demand destruction caused by the coronavirus pandemic is "well in excess of the oil industry's capacity to adjust," the International Energy Agency warned Wednesday.

The IEA, in a piece published on its website, said the ferocity of the current crisis had never been matched in the history of the oil market.

"Comparisons with previous periods of disruption in oil markets are inevitable but misplaced. The oil industry has never seen anything like 2020," the agency said.

The coronavirus pandemic has forced much of the world to go into lockdown, dramatically cutting oil demand, and oil prices have fallen by almost 75% since the start of the year, with some producers now losing money on every barrel they produce.

This demand shock has occurred just as the world's biggest oil suppliers, Russia and Saudi Arabia, backed away from a production agreement and plunged into a battle for market share. These events together have completely transformed the oil market, throwing it off its axis.

Platts Dated Brent, the world's most liquid physical benchmark, fell to a 19-year low of $17.68/b on March 31.

The Paris-based body's executive director Fatih Birol in a tweet said he expects "some production to grind to a halt," adding that investment cuts will hit the whole industry, with impacts on the "wider energy sector, economy and trade."

Around 5 million b/d is not fetching high enough prices to cover the costs of getting it out of the ground, based on an ICE Brent price of $25/b, according to the IEA.

Last week, Birol said oil demand could be as much as 20 million b/d below its expected level of 100 million b/d at points this year. With more lockdowns coming in across the world and extensions of existing ones, estimates of demand contraction are likely to be revised higher in the coming weeks.

"As demand plummets, the entire supply chain of oil refining, freight, and storage is starting to seize up, making it increasingly difficult to push new supply into the system," the IEA said.

PROFOUND IMPACT

The IEA noted that if prices continue to fall there "could soon be no place" for oil to go and oil companies will have to undertake sharp cuts in new investments.

The independent US companies and shale producers are likely to bear the first brunt of this new reality.

"Projects considered low cost yesterday (those that are viable at $35-45/b) already look high cost today, and only the most resilient investments have a chance of going ahead. Companies are pushing back other plans and redesigning them where possible in order to seek ways of driving costs even lower. Otherwise, they are shelving these projects entirely," it added.

The IEA stressed that the impact to some oil exporters will be profound, bringing risks to their social and financial stability.

The piece singled out OPEC members Iraq and Nigeria, saying their ability to continue to pay salaries and provide essential services such as healthcare and education will come under pressure.

The refining sector, which normally benefits from lower oil prices, is not immune to the crisis, the IEA said.

Some refineries face an existential threat as demand for their most lucrative products like jet fuel, gasoline and diesel is evaporating.

The plunge in demand has squeezed refinery margins and volumes, and refiners are already mulling temporary shutdowns as their storage capacity reaches its limit.

"With demand now in free fall, the excess capacity now looms very large over the industry, posing an immediate threat to the outlook for older and more exposed operations," it said.

ENERGY TRANSITION PROSPECTS

The organization also warned that the present situation will affect the prospects for the clean energy transition, easing some aspects while complicating others.

"Although demand for oil will rebound when the crisis eases, the dislocation could accelerate some structural changes in the way the world consumes oil," it said.

The link between oil and gas prices is also set to disappear as international gas suppliers struggle to cover their operating costs.

But it did acknowledge that gas demand is less exposed to the current crisis compared to oil demand because of its relatively limited use for transport.