Covid-19 Impact On Energy Markets Has A Long Tail
“Covid-19 has disrupted everyone’s lives, and we can only speculate on what behavioral changes might be more than temporary. BP’s economists have taken a stab at the long-term impact it will have on oil demand.”
During the BP 2020 Outlook presentation last week, the company’s chief economist Spencer Dale discussed their assessment of the long-term impact on economic activity, and thus on energy consumption, from the Covid-19 virus. The company’s focus scenario when explaining future energy changes in response to events is its Rapid Transition Scenario. That scenario assumes government policies significantly increase carbon prices, along with taking sector-specific steps to cause carbon emissions to fall by about 70% by 2050. This scenario is consistent with actions designed to limit the rise in global temperatures by 2100 to well below 2o C above preindustrial levels.
In Rapid, Covid-19 is projected to reduce economic activity (GDP) by 2.5% in 2025 and by 3.5% in 2050 from what it would have been otherwise. The reductions will be disproportionately borne by India, Brazil and Africa. A portion of the reduction reflects anticipated behavioral changes such as reduced air flights, mobility, trade and manufacturing. The fallout on energy calls for a 2.5% reduction in 2025 and 3% less in 2050, meaning that oil demand would be three million barrels per day (mmb/d) below expectations in 2025 and 2 mmb/d below 2050. That outcome is shown in Exhibit 23.
Exhibit 23. How BP Sees Covid-19 SOURCE: BP
BP also presented a scenario reflecting a greater economic impact, largely due to a second wave of the virus and longer-lasting and deeper behavioral changes as a result. The impact is for global GDP to be 4% below expectations in 2025 and almost 10% below its 2050 target. The fallout on energy and oil demand in 2050 could be -8% and -5 mmb/d, respectively.
Exhibit 24. How Bad Covid-19 Could Be For Oil SOURCE: BP
These negative assessments come at the same time both the International Energy Agency (IEA) and the Organization of Petroleum Exporting Countries (OPEC) are revising down their oil demand estimates for the balance of 2020 and their preliminary recovery forecasts for 2021. The lower oil demand, which is marginal (a few hundred thousand barrels per day) is the result of lowered economic growth projections. We found it interesting that both organizations reduced their economic growth forecasts, while at the same time, the Organization for Economic Cooperation and Development (OECD) raised its September forecast from its June prediction. Fitch Solutions, a global credit rating organization, has also increased its economic projections.
In the case of Fitch Solutions, it now predicts a -4.4% decline in global GDP in 2020, 0.2% better than its earlier forecast. This is because the recovery has happened faster than anticipated, even though the pace of the recovery is slowing. It is interesting that its 2021 and 2022 GDP forecasts call for growth well above the 2015-2019 average annual growth rate of 3.0%. In 2021, Fitch Solutions sees world GDP rising by 5.2%, followed by 3.6% growth in 2022. Those growth rates should help boost global energy demand, as well as oil demand. Shortfalls in oil demand from normal would likely reflect behavioral changes such as BP is suggesting. It is hard to believe there will not be changes, but predicting what they will be, and how much they will impact oil demand, remains difficult to call.
The OECD forecasts are interesting, and are shown in Exhibit 25. The blue and black dashed lines represent the OECD’s June 2020 forecasts, while the light red lines are its recently released September forecasts. Like Fitch Solutions, the OECD anticipates a smaller economic decline in 2Q2020 and a sharper rebound. It appears that the shape of their recovery mirrors their June recovery pace (black dashed line).
Exhibit 25. OECD Sees Global Economy Healthier SOURCE: OECD
The single message we take away from all the forecasts and guestimates is that oil demand will be below what it would have been absent Covid-19, and that will likely be for years. The magnitude of the shortfall can be debated endlessly. Our assumption is that we are looking at something close to BP’s estimates of -2 to -3 mmb/d shortfall. In a world of 100 mmb/d oil demand pre-virus, this is not a catastrophe for the oil industry. It will, however, force managements to begin assessing the shape of the long-term oil demand curve and what strategy adjustments may be necessary.