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Is This the End for Oil?

Covid-19

Why $10 a barrel might mean the party’s over

In three months, the price of oil has tumbled from $65 to $1.50 at the time of writing. Seemingly nothing can stop the rot. Price has fallen over 90% today alone. I’m staring at my screen in disbelief as I’m watching price in real-time looking to go below a dollar.

In fact, I’ve had to edit this piece as when I posted it two hours ago, I mentioned price might break below $10. We’re now looking at the biggest decline in oil price ever.

The coronavirus pandemic has left oil producers with enormous excess. With businesses closed, hundreds of millions of people at home and nearly all flights grounded, demand has plunged dramatically.

There are increasing fears that the total capacity of oil storage in the US will be full in a few weeks, meaning production will be forced to stop. It’s expected that fracking will suffer enormous waves of bankruptcies and countries with enormous oil reserves — like the US, Canada, Russia and Saudi Arabia — will be hit with financial losses on a potentially unprecedented scale.

Cracks are beginning to show. Oil giant Occidental Petroleum is paying its quarterly dividend of $200 million in shares rather than cash because of it’s growing debt and limited income.

With the pandemic continuing and few countries showing signs of easing restrictions, fears of a global recession similar to the Great Depression could weigh even further on oil.

As one strategist puts it, there’s simply “too much oil, with nowhere to put it.” Indeed, last week OPEC+ members including Russia decided on cutting output by 10 million barrels per day until at least the end of June to prop up prices in a bid to end a harsh price war, seemingly to no avail. Plus, Russia’s cuts don’t actually take place until May, meaning normal production carries on until then.

To make things worse, Saudi Arabia sent a fleet of oil tankers to the US prior to last week’s OPEC+ meeting containing seven times as much oil as they sent in a typical month last year.

The International Energy Agency warned that despite production cuts, “there is no feasible agreement that could cut supply by enough to offset such near-term demand losses”. They estimate that output this December will be close to 2 million barrels per day less than in December 2019.

Part of the steep decline in price today is thought to be due to futures contracts expiring tomorrow, meaning that unless traders get rid of them, they would have to take delivery of the physical barrels. Nonetheless, there could be significant long term damage.

In the past, people believed that the end of oil would come from the ‘peak oil’ scenario. This is the idea that oil production would begin a long decline, dramatically inflating prices as no alternative was available.

The opposite scenario is now gaining traction. This is the argument based on the increasing popularity of clean energy alternatives, especially regarding electric vehicles, therefore limiting demand for oil. Although clean energy is undoubtedly gaining enormous momentum, it has been the coronavirus pandemic that has collapsed prices.

Nonetheless, the global focus on climate change and strides in the direction of clean energy could spell the end for many oil companies. The head of commodities at Goldman Sachs recently said that covid-19 will “permanently alter the energy industry and its geopolitics, restrict demand as economic activity normalises and shift the debate around climate change.”

If indeed we do see oil companies fail, we could begin to see the transition to a low-carbon economy quicker than we’d imagined. The likelihood that businesses in an industry that many countries aim to move away from will be bailed out is very slim.

Any talks of government bailouts of the oil industry would likely be met with enormous backlash. Potential financial assistance, it could be argued, would be better spent developing and building the clean energy industry and reskilling oil workers that may lose their jobs. Not only would this set course on a more sustainable future but would also provide a strong return on investment.

We may well see only the strongest and largest oil companies prevail over the coming months, signalling a shift to a much smaller oil industry.

Of course, oil hasn’t immediately become obsolete due to a global pandemic, and as restrictions ease in the near future, demand will slowly trickle back in. Naturally, oil will stage some sort of recovery, however, unlike the aftermath of other recessions, I’m not sure the bounce back will be anywhere near as strong.

The next few months will give us a glimpse into the future of this industry. Unless we see a considerable rebound, the transition to clean energy alternatives on a mass scale may happen sooner than expected.

Edit — Oil futures contracts ended at-$37.63

 

This article was originally published by Marcus Arcanjo, Medium.com

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