The COVID-19 pandemic has impacted much of the global economy, and the oil market has been one of the hardest-hit sectors.
The COVID-19 pandemic has dramatically altered nearly every facet of modern life, including much of the global economy, and its effects aren’t yet letting up.
One of the hardest-hit economic sectors has undoubtedly been the world’s oil market. The dramatic increase in teleworking and remote learning has led to significantly reduced demand for oil products — consumers are driving less, and they’re also flying less. In fact, of the oil market segments, aviation fuels has been the most impacted by the reduction in business and leisure travel.
Oil prices quickly dropped to negative levels last April on the back of coronavirus global lockdowns. The unprecedented action meant producers had to pay downstream customers to take their crude.
While the situation has improved somewhat, in the fall of 2020, continued downward pressure on oil demand led the International Energy Agency (IEA) to issue an alarming report about the state of the market. The report, along with grim outlooks from major oil producers BP (NYSE:BP,LSE:BP) and Royal Dutch Shell (LSE:RDSA,NYSE:RDS.A), had some oil analysts asking if peak oil has been reached.
The COVID-19 lockdowns that began in 2020 have continued into 2021 as countries around the world grapple with second and even third waves of the coronavirus in the face of slow vaccine rollouts. Not only has this stalled a return to everyday life, but industry insiders such as Robert McNally, a former advisor to George W. Bush and current chairman of Rapidan Energy Group, have pointed out that many governments are looking to leverage the pandemic “as an opportunity to rethink energy policy” and accelerate the transition to a clean energy economy.
The dire implications for the oil sector are reflected in the IEA’s Oil 2021 report, which warns that oil demand growth may never return to “normal” if the teleworking and clean energy transition trends continue. Depressed oil demand is also impacting the oil supply outlook, and so are “sharp spending cuts and project delays are already constraining supply growth across the globe.”
COVID-19 and oil demand
If the trends of working from home and reduced travel continue post-COVID-19, and if governments enact proposed clean energy policies, the IEA believes the oil market could be permanently altered for the foreseeable future. This scenario could reduce global oil consumption by as much as 5.6 million barrels per day (mb/d) by 2026, ensuring that worldwide oil demand never recovers after the pandemic.
At the same time, the IEA points out that the underlying fundamentals for oil demand over the long term are strong, particularly in light of increasing energy demand from developing Asian economies.
The rising trend in online shopping also bodes well for freight fuel, according to Bloomberg. The transportation sector, namely the trucking and shipping industries, comprises the majority of today’s oil demand and is expected to remain highly dependent on petrol products.
In the base case highlighted in its Oil 2021 report, the IEA projects that by 2026, global oil demand will reach 104.1 mb/d, representing an increase of 4.4 mb/d from 2019.
This demand growth will not be spread equally between regions and oil products — emerging and developing economies in Asia are expected to account for 90 percent of demand growth for the forecast period, while oil demand in Organization for Economic Co-operation and Development (mainly western) countries is not expected to return to pre-pandemic levels before 2026.
In terms of oil products, more fuel-efficient internal combustion engine vehicles and the shift to electric vehicles is expected to dampen gasoline demand. The growing prevalence of Zoom (NASDAQ:ZM) meetings and online conferences has cut the need to travel for business and with it the demand for aviation fuels, which is not expected to return to pre-COVID-19 levels before 2024.
“(COVID-19) caused a historic decline in global oil demand — but not necessarily a lasting one. Achieving an orderly transition away from oil is essential to meet climate goals, but it will require major policy changes from governments as well as accelerated behavioural changes. Without that, global oil demand is set to increase every year between now and 2026,” said Dr. Fatih Birol, the IEA’s executive director.
COVID-19 and oil supply
The COVID-19 pandemic has not only changed the oil demand picture, but has also altered the oil supply side as well. According to the IEA’s data, declining demand in 2020 left the global oil market with “a record 9 mb/d spare production capacity cushion that would be enough to keep global markets comfortable at least for the next several years.”
However, the notable shift in capital from fossil fuels to clean energy by governments, and even the big oil companies themselves, is likely to curtail the expansion of global oil production capacity.
A 2021 survey conducted by market research firm DNV GL found that 57 percent of senior oil and gas industry professionals are actively taking steps to increase the role of renewables in their energy mix, up from 44 percent who were doing so in the previous year.
“The financial markets — through the effects of the COVID-19 pandemic — have seen what peak oil demand could look like, and are increasingly factoring in changing sentiment in society towards a decarbonized future. Decarbonization has moved from something on the horizon to an immediate priority, and there are signs that our sector may invest to transform rather than cut its way out of the present crisis,” said Remi Eriksen, group president and CEO of DNV GL.
The IEA states that upstream investment in oil production capacity for 2020 was down by 30 percent from 2019 levels. The agency expects that such spending will increase in 2021, but “only marginally.” The situation may result in a tight supply scenario for the oil market by 2026, with production capacity expanding at only half the rate needed to match anticipated demand. “By 2026, global effective spare production capacity (excluding Iran) could fall to 2.4 mb/d, its lowest level since 2016,” warns the IEA.
While the US oil industry has dominated global oil supply growth in recent years, a looming supply deficit could benefit nations that are part of the Organization of the Petroleum Exporting Countries, including Saudi Arabia, Iraq, the United Arab Emirates and Kuwait.
On the demand side, the US is the world’s largest oil-consuming country, and social distancing restrictions are relaxing at the same time as COVID-19 vaccine rollouts are in overdrive. That, coupled with another round of government financial aid, is expected to create a surge in crude demand in the country, according to Commerzbank analyst Carsten Fritsch.
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Securities Disclosure: I, Melissa Pistilli, hold no direct investment interest in any company mentioned in this article.