The coronavirus pandemic has accelerated change in the global energy system, from historic declines in GHG emissions, inflections in demand trends and shifting production patterns, to an increased energy transition focus and aspirations towards net-zero emissions, writes S&P Global Platts' global director of analytics, Chris Midgley.
What a difference a year makes. This time last year at the S&P Global Platts Global Energy Outlook Forum we were anticipating that 2020 would be all about IMO 2020, which was set to bring upheaval to the shipping sector but opportunity for refiners.
In addition S&P Global Platts Analytics was forecasting weather to have a larger impact on commodity supply and demand, dislocation between Dated Brent and ICE Brent futures, a tightening of US natural gas supply/demand balances, agriculture facing ongoing impacts of trade wars and African Swine Fever, and a greater focus on climate change, with hydrogen in the spotlight. Most of these forecasts weren't wrong, but none of us imagined the primary driver of market dynamics would turn out to be a global pandemic.
That said, 2019 did end with the gasoil-fuel oil spread blowing out to over $50/b as shippers switched to 0.5% sulfur fuel oil ahead of the January 1 IMO deadline. Fuel oil fell down to coal parity pricing, as it had to compete with LNG and coal into thermal power. Initially it was the weakening of the gasoil crack that narrowed the spread, as the mildest winter on record softened heating oil demand by far more than the increase from demand for gasoil into bunkers. With a loss of 800,000 b/d demand, simple refineries started to cut runs, resulting in a tightening of supply of high sulfur fuel oil, which pulled the gasoil-fuel oil spread back below $30/b.
OPEC+ pact crumbles
In March, even as the reality of the pandemic was rapidly dawning, a price war suddenly broke out in the oil market. Russia decided it had had enough of providing price support, arguing that the strategy had allowed the US shale industry to take too much market share, and with this the OPEC+ agreement collapsed. In response Saudi Arabia immediately vowed to flood the market, an ill-timed move that came only days before the World Health Organization declared the novel coronavirus a global pandemic.
Just as OPEC and Russia were piling supply onto the market during April, global oil demand was collapsing by an unprecedented amount — more than 20 million b/d. Fossil fuels across the board fell to coal parity, as ahead of a supply response they all competed for what little demand was left, triggering coal-to-gas switching and driving the ICE Brent crude futures structure into a steep contango to incentivize floating storage, in what proved to be an unexpected windfall for the shipping industry.
Despite US crude futures benchmark WTI trading in negative territory for the first time ever, and tumbling all the way down to a historic low at minus $37/b during a chaotic expiry of the front-month contract on April 20, commodity prices in general behaved in a rational manner to address the multitude of supply-demand imbalances.
Crude prices fell to curtail production, initially gasoline cracks collapsed and gasoil rose in order to rebalance refinery production in response to the collapse in passenger transportation. Natural gas liquefaction margins went negative in the US, causing utilization to eventually fall below 40%. With major curtailments to air travel, jet fuel prices collapsed, incentivizing refineries to displace it, 70% to gasoil, 30% to heavy naphtha. This in turn forced gasoil cracks down and caused refinery margins to rapidly converge to zero, resulting in huge refinery run cuts.
With Russia and Saudi Arabia overcoming their differences in the face of collapsing oil prices, OPEC++ responded with a historic agreement to cut production by almost 10 million b/d. Prices found support but with the majority of cuts coming from heavy sour crudes, the yield of HSFO declined and with it the gasoil-fuel oil spread collapsed to just $10/b.
The pandemic has led to vast cuts in upstream capex across the industry, but the US shale sector has been hit hardest, with a 40% collective cut in spending and, at one point, rigs and frack crews collapsing by 80%. The pandemic has done more than any OPEC deal could have achieved to rein in production from the US shale oil patch — production has declined by 1 million b/d this year and is forecast to drop a further 1 million b/d next year. In 2021, OPEC's market share will rise for the first time in five years, but with that, oil prices will become increasingly vulnerable to geopolitical tensions in the Middle East.
The fall in US shale production has also resulted in a loss of associated gas production. With LNG demand recovering in Asia, and hurricane disruptions in the US Gulf Coast impacting supply and liquefaction, the Platts JKM price benchmark for Asian LNG has rallied and improved US netbacks. That in turn has tightened US natural gas supply-demand balances.
The more bullish natural gas and LNG outlook is in stark contrast to the bearish oil outlook. While gas and power demand are benefiting from a recovery in industrial activity and duplication in demand from heating and cooling of homes and offices with the widespread switch to working from home during the pandemic, oil demand has been heavily hit from the fall in aviation and lower passenger vehicle miles travelled. This narrower gas-to-oil spread has had impacts on petrochemicals, shifting the advantage in US gas (ethane) cracking to liquid (LPG/naphtha) cracking in Europe and Asia, with LPG getting an additional boost from home cooking and heating — and those outdoor heaters that enable outdoors socially distanced meetings to occur.
While demand for most petroleum products has been negatively impacted, overall petrochemicals have seen year-on-year demand growth, as packaged goods and PPE leant support. While aviation has clearly been heavily impacted, gasoline and gasoil have seen mixed fortunes. Avoidance of public transport has driven increased use of personal transport, whether private jets for a small minority of the world's population, second-hand cars bought by a larger constituency to enable safer commutes, or even, in the US, recreational vehicles as holidaymakers hit the road for their socially distanced holidays.
Long-term economic impact
It is here that we have seen significant signs of wealth inequality, as consumers adapted to the pandemic in whatever way their income allowed. Nevertheless, in a year where inequality has rightly been put in the spotlight, too little has been said about wealth inequality and its deeper, longer-term impacts.
GDP is unlikely to recover to pre-COVID levels until 2022, but less talked about is the "global regression" associated with the pandemic. Millions of people have become permanently unemployed and as a result families will not be able to afford to pay for education, limiting the employment potential of millions of young people who have not recovered from the huge loss of jobs after the great recession.
This "global regression" will result in 400 million people being pushed out of the middle classes over the next 10 years who would have contributed to over 300,000 b/d of oil demand growth each year. Therefore, excluding petrochemicals we expect oil demand to peak 3.5 million b/d lower, but also earlier, at the turn of the decade. This near peaking of demand coupled with a 7 million b/d increase in refinery capacity over the first five years of this decade is likely to lead to peak refining and consolidation in capacity due to weak margins. In addition, recent trends have seen an increase in conversion to biorefineries that turn used cooking oil or tallow into renewable diesel and sustainable aviation fuel, which along with NGLs will displace the need for refinery capacity.
The one big winner of the pandemic has been the environment, which has seen GHG emissions decline more than at any time in human history, enabling us to enjoy clean air and blue skies. In addition, we have seen an increased focus on the energy transition, supported by green stimulus in Europe and commitments to net zero emissions from both international energy companies and countries — most significantly China.
This ambition has seen a move away from enthusiasm for natural gas and LNG as a bridge fuel in the energy transition to a focus on renewable electricity and hydrogen. In reality, the world is going to need a mosaic of integrated energy solutions to achieve its ambition. This is why S&P Global Platts Analytics has rebranded and launched our new Future Energy Outlooks offering, which aims to help our customers navigate the significant future uncertainty with our long-term outlooks, thought leadership on energy pathways, analysis and ranking of asset carbon footprints, as well as tracking of signals and signposts of future direction.