The Impact of COVID-19 on the Oil Industry
The spread of Covid-19 poses a significant threat to the global oil and gas industry. The increasingly drastic action taken to reduce the spread of the virus interferes with many of the sector’s key processes: offshore workers have to balance maintaining social distancing while living and working in confined spaces; travel bans and quarantines inhibit companies’ ability to travel and conduct meetings; and the uncertainty that runs through the pandemic does nothing to reassure a historically volatile industry.
This uncertainty is furthered by the lack of an obvious historical precedent for the phenomenon in the oil and gas sector. The International Energy Agency (IEA) has pointed to the 2003 SARS pandemic as a loosely analogous event, but noted that a centrepiece of both the Covid-19 outbreak and the global oil industry, the part played by China, has changed dramatically in the last two decades.
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As the agency notes, since 2003, China’s oil demand had more than doubled, and by 2019, Chinese growth accounted for more than 80% of global oil demand growth.
The disruption to Chinese oil has had repercussions felt around the world; in February, the IEA noted demand had fallen by 435,000 barrels per day (bpd) in the first quarter of this year alone, the first quarterly contraction in demand in more than a decade. The following month, the agency reported that the shutdown of the Chinese economy in the wake of the virus has triggered a collapse in global oil demand of 1.1 million bpd compared to 2019 figures, and slashed its annual growth forecast by more than a quarter, to 825,000 bpd, the lowest growth figure since 2011.
Energy research firm Rystad Energy went a step further, predicting that a 25% decline in oil prices could see oil and gas investments cut by $30bn globally, severing an economic lifeline for an industry that has already been casting its eye towards long-term decommissioning projects rather than new drilling opportunities. As a result, the pandemic could prove to be an existential threat for the oil and gas industry, as social and economic challenges force a historically conservative sector to adapt to a rapidly changing environment.
While there are some causes for optimism, notably the industry’s response to the 2014 oil crash providing a basic framework for future crisis management strategies, it remains unclear if the oil industry is properly structured to respond to this emergency.
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By GlobalDataLow demand and lower prices
The sudden spread of Covid-19 has plunged many of the world’s oil production centres into limbo, with closures and uncertainty in China leading the way. According to Carbon Brief, the percentage of oil refineries in operation in the province of Shandong fell from 71.4% in December 2019 to 38.9% two months later, a collapse of close to half that is symbolic of a wider, sudden industrial outage. Similarly, government figures have shown a 3.3% decline in crude oil processing in the first two months of the year, compared to the same period in 2019, and a 6.6% fall in the production of refined oil.
This decline in production has precipitated a near-identical decline in oil prices. Figures from Trading Economics show that the price per barrel of oil has collapsed in the last four months, from a peak of $64.58 on 5 January to a low of $20 on 1 April. This drop has been hastened by two periods of significant declines: a fall from $47.80 to $30.16 between 5 and 9 March, and a fall from $33.33 to $20.23 between the 13 and 18 of March.
These last two figures are beyond the scope of the reports released by the Chinese Government, which found some positive outcomes in a 3.5% increase in total crude oil production compared to the first two months of 2019. There is a real concern that after this brief bubble, oil production across China could be plummeting.
These twin challenges have created twin problems, with social and economic costs of the virus tied at the hip.
“There are two avenues that companies are thinking about right now,” said Yvonne Telford, senior analyst for north-west Europe at Westwood Global Energy, highlighting these issues. “The health and safety of the workers, maintaining the security of supply through this crisis; and also then looking at the oil price and the activities that are required and necessary.”
Social impacts and structural issues
Telford highlighted the particular risk faced by UK offshore workers, with many of them classified as essential workers due to the importance of oil and gas production in north-west Europe.
“What you’ve got is a collective of people from all areas of the UK, from the Shetland on the far north of Scotland right down to Brighton, and Cornwall, who are having to travel from their respective regions [and] they have to then go offshore and work together with people who have been excluded or may not be exposed,” she said. “It’s almost like a hotel offshore, or a cruise ship for example, they are perhaps a good example; but without thousands of people, you have anything from 40 to a couple of hundred people on a platform, but they’re in a very confined space.”
There is also a structural issue at work here, that countries such as the UK and Norway simply have to keep producing oil, unlike bodies such as OPEC which can halt or advance production to carefully regulate supply and demand. Telford pointed to the “diversity of the corporate landscape in the UK” as a key contributor to this urgency to produce. The mishmash of different companies and operators, some very large and some very small, operating in the UKCS means that a single administrative body cannot impose a single policy to regulate oil production and supply, as no single policy would benefit all of these producers.
So entrenched is the need to maintain production that operators on the UKCS are willing to keep working, even if they do so at a loss. A piece published by Westwood, and authored by Telford, noted that cost, comprised of operational expenses and planned capital expenditures, on the UKCS had reached over $15bn, and unless the oil price remains steady at above $27 per barrel, these operators will not be generating enough income to cover their costs.
Learning lessons and looking ahead
Despite these challenges, Telford was optimistic about some aspects of the oil industry’s response, pointing to events such as the 2014 oil price crash, which saw the price of a barrel of oil tumble from $115 to $35 in just under two years, as helping the UK oil industry to prepare for future challenges.
“We had this initial culling of projects, but then what we saw, a year or two after that, was a real kind of business attitude at platform whereby the teams really worked at improving their operational expenses to barrel of oil equivalent costs,” she said, highlighting the industry’s renewed efforts on aligning operational expenses with the actual profits from selling a barrel of oil. Her report, published by Westwood, noted that 11% of forecast UK production for 2020 comes from assets with operating costs of under $20 per boe produced, compared to just 2% in Norway.
Yet this consideration does little to address the fundamental issue, of a rigid industry having to adapt quickly. The very nature of private oil production, exemplified by the myriad range of companies operating in the UKCS, means that the vast majority of the industry cannot change course quickly enough to prevent much of the damage from a crisis like this, and even bodies with this nominal power are struggling to wield it effectively. OPEC is one such group, and Telford called on them and their allies to take on more active leadership roles.
“Collaboration between companies is always talked about and it’s great in theory,” she said. “To collaborate on a global scale, I think OPEC and OPEC Plus [as] the groups who are well positioned to understand the negotiations required to agree production terms, to agree the production levels, to stabilise the oil price and if reports over the weekend are to be believed, then, we may see them getting back to the table sooner rather than later.
“It is critical that OPEC Plus can come to some agreement to stabilise the price because a $20 per barrel oil price does not help Russia, it does not help Saudi, so globally there needs to be some work.”
