The covid-oil crash double whammy
  • Anish De, Partner |

As businesses across the board come to terms with the adverse impact of covid-19, the oil sector has become witness to massive volatility and downturns. West Texas Intermediate (WTI), the marker for US crude turned negative on 20 April 2020 due to demand collapse and the lack of adequate storage capacity. Global supermajors have witnessed erosion of their market capitalisation by 40-50% over a six-month timeframe. Liquidity in the market has become extremely tight for most players across the value chain. In the oilfield services sector, there have been a number of layoff or furlough announcements. The global oil industry has witnessed shocks, but never on this scale. The disagreements among key producers on the quantities to produce keeps the market perpetually on tenterhooks.

For India, the low crude oil prices provide some relief on input costs as well as on the current account situation. Given that the country imports about 85% of its crude and half of its gas, there are clear economic benefits. However, individual organisations may bear the effect in their respective sectors, depending on the segment they operate in and specific circumstances. Even the main refiners are likely to book huge inventory losses since the large amount of oil that they hold has on paper come to be of much lower worth when marked to the market.

With lockdowns in place across the world, and owing to the volatile circumstances surrounding energy demand, supply as well as competition from alternate energy has made it extremely challenging to project a price range. Prices of Brent Crude, the typical marker used in India, has been under $30 per barrel for much of April 2020 and has fallen under $20 lately. This is unviable for the industry and is likely to have long-term implications for investments and even basic business continuity. Nevertheless, tepid prices may persist for a period of time because of the descent of demand due to covid-19 and the uncertain recovery path with the waves of lockdown. Moreover, with overflowing storage, any surplus will most likely be sustained, keeping prices subdued.

Traditionally, the biggest advantages of oil have been a consequential outcome of its high energy density, storability and relative use of transportation. Those key advantages have diminished in value as inventory has built upon a scale that has never been seen before. Supertankers full of crude oil and products are being utilised for floating storage. Oil markets have lost the flexibility in coping with these enormous headwinds.

Estimating pump prices in India has become an equally difficult endeavour. There are a number of processes involved between the crude production and pump prices, not to mention the lag between oil and product prices, in addition to various taxes and duties. While the domestic petrol and diesel prices may not be moving in exact tandem with their benchmarked Arab Gulf prices, the directional movement would be similar. Also, in a controlled market like India, we do expect the oil marketing companies to be relatively shielded and being able to control the pump prices to cover some of the inventory losses. The government is also likely to adjust the excise duties as it has done in the past to mop up revenues, which is a critical priority as the country deals with covid-19 and its aftermath.

However, oil remains essential for moving the wheels of the economy. Once supply chains return to normal and all restrictions pertaining to quarantine and travel are lifted, demand will increase, and oil prices should firm up from current levels. However, the full year international crude price forecast is of the order of $30-35 per barrel, given the relatively slow recovery of demand foreseen in the context of the prospect of waves of infections and lockdowns to manage covid-19. Pump prices are expected to stay relatively stable around current levels

The industry will have to go through its own belt tightening by several notches, but simultaneously build in agility and resilience. Oil and gas leaders are being forced to consider new ways to adapt to the needs and safety of their people, adjust business operations and models and fulfil evolving customer demands in order to return to stability and growth. From spending cuts, dividend reductions, or hiring freezes to paring down staff or re-evaluating their footprint and partnerships, companies are taking significant actions. Zero-based budgeting is also the new mantra to cut flab and stretch limited resources based on emergent priorities for survival. One key realisation across the industry is that covid-19 is not a one-off black swan event. In various shapes and forms these challenges will present themselves in the future as well, and perhaps with greater regularity. A clearly visible urge is to go digital as much as possible to bring in resilience in operations, have higher levels of visibility across the extended chain, and the ability to work from anywhere when such disruptions occur.

The Indian/Asia cracks are really low at the moment and recovery of demand is uncertain; this may remain so for some time. Globally, investment dollars are being sharply cut back, and this could be the case in India as well. On upstream projects, the prospectivity of India has traditionally been perceived to be relatively poor. At the current prices, coupled with the liquidity shortages, it is difficult to foresee any new project breaking ground. Even projects that are in early construction stages may be delayed. The present prices and lack of visible resolution on both the demand and supply sides make any investment decisions in upstream oil and gas super risky. Downstream investments will clearly watch demand trends and we may see more readiness for brownfield investments and debottlenecking projects than greenfield asset build-up.

Investors in oil will remain wary. Already, energy transition had set in and most players in the oil industry have started diversifying. Some companies have very significantly overhauled their asset portfolio and moved to clean energy. Other supermajors seem to be following suit and the stated goal is to move to clean energy at scale. Clean energy has inherent advantages of less complicated supply chains. When combined with energy storage, it is emerging as a viable alternative to oil investments for these players. The covid shock will only accelerate that trajectory. In the meantime, the oil sector will inevitably witness bankruptcies, and explicit and implicit bailouts given the strategic economic interests involved and the associated politics, especially in a US election year.

Make no mistake, oil may be cheap at this time, but it is the largest element of the energy basket today. Developments in the oil sector are incredibly important for the global economy and its recovery in the aftermath of this global pandemic. However, covid-19 may also push new investments to more benign and less complicated energy resources, accelerating the global energy transition.

(A version of this article appeared in Mint on April 29. 2020)