Imagining The Oil Recovery Requires Thinking About Demand
For some companies, shifting investment focus away from traditional oil and gas and toward renewables has become a priority
The cataclysmic collapse in oil demand, as governments moved to combat the Covid-19 virus, aggravated by the oil war between Russia and Saudi Arabia, has forced the energy industry to rush to adjust. Actions have included slashing capital expenditures, shutting down producing wells, stopping drilling new wells, and now restructuring operations, which means laying off employees and downsizing organizations. For some companies, shifting investment focus away from traditional oil and gas and toward renewables has become a priority, largely driven by the social mandates of its customers, shareholders and governments.
The initial concern when economies shut down and oil prices collapsed was how to mitigate the tsunami of crude oil speeding to markets that didn’t need the additional supply. It was fear of the industry exhausting storage capacity that drove oil prices into negative territory for the first time ever. In hindsight, estimates of oil demand destruction and fear of overflowing storage tanks proved to be overly pessimistic. In some ways, the pessimism was muted by the involvement of President Donald J. Trump in resolving the dispute between Russia and Saudi Arabia, leading to a sharp, and so far, highly compliant, oil production cut for OPEC+.
Once the market realized the catastrophic outcomes weren’t happening, the focus shifted to what the recovery might look like. Recovery scenarios have become the focus for many forecasters, and their scenarios continue to be updated with the latest market data, as well as revised expectations about how quickly economic activity is recovering. Some of the early scenarios were extremely negative, assuming that the virus would force the economic shutdowns to extend well into the summer and even possibly into fall when a second wave of infections might be experienced.
As the reopening of economies has occurred, the oil recovery scenarios are being modified. We are fortunate that the three major oil forecasting groups – the Organization of Petroleum Exporting Countries (OPEC), the International Energy Agency (IEA), and the Energy Information Administration (EIA) – have recently revisited their views about the current oil market state and the recovery.
In the OPEC Monthly Oil Market Report for June, the organization did not make any change to its prior month’s projection of a decline of 9.1 million barrels per day (mmb/d) in demand for 2020 compared to 2019. The annual total reflects a decrease in the first half of 2020 of 11.9 mmb/d, but only a 6.4 mmb/d decline during the second half, reflecting a gradual recovery in economic activity toward the end of 2020. They see a moderate first quarter decline coupled with a 17.3 mmb/d second quarter decrease. What we don’t know is what OPEC thinks about oil demand in 2021 and beyond.
The IEA released its June Monthly Oil Report in which it expects demand in 2020 to fall by 8.1 mmb/d from 2019’s level. The organization’s demand forecast has been raised by 500,000 barrels per day due to stronger consumption during the Covid-19 lockdowns than previously estimated. The IEA also offered its first projection for demand in 2021. It sees demand rising by 5.7 mmb/d from 2020’s level. Of course, at 97.4 mmb/d of demand for 2021, it is still 2.4 mmb/d below 2019 levels, although the IEA cautions its projections are subject to change based on the uncertainty about the pace of the economic recovery. To reinforce that point, it says the decline in air travel, which contributed to a 3 mmb/d drop in jet fuel and kerosene in 2020, will lag in recovering such that the IEA projects only a 1 mmb/d increase in 2021, leaving demand well below 2019 levels.
Given the economic uncertainty, forecasters are turning to unlikely data to measure the recovery pace. Rather than rely on monthly retail sales, new home sales, or building permits data, forecasters are now clamoring for more frequent data, which reflects how many people are engaged in certain activities or how they are spending their money. An article in The Wall Street Journal focused on a handful of these daily data measures that, with the aid of smoothing with seven-day moving averages, provides a gauge of how activity has changed since the onset of Covid-19 and the economic shutdowns. The article contained charts covering the following data series:
· People dining in restaurants, percentage change from a year earlier
· Number of travelers who passed through TSA checkpoints
· Apple Maps directions requests in the U.S., change from Jan. 13.
· Foot traffic to businesses, change from early March baseline
· Index of online spending on grocery pickup and delivery services
While all the data series don’t show upward trends, the one economic series showing a decline is actually down because it was a primary beneficiary of the pandemic and economic shutdowns – grocery pickup and delivery services. Given concerns over catching the virus while shopping for groceries, people embraced pickup and delivery services, something grocery stores introduced and/or actively expanded and promoted. The fact that this measure is down is a manifestation of more people actually shopping in grocery stores.
More People Are Eating At Restaurants More People Are Flying Today
Exhibit 6. More People Are Eating At Restaurants Source: WSJ
Exhibit 7. More People Are Flying Today Source: WSJ
More People Are Driving Today Shopping Traffic Has Picked Up
Exhibit 8. More People Are Driving Today Source: WSJ
Exhibit 9. Shopping Traffic Has Picked Up Source: WSJ
How Grocery Pickup And Delivery Declined
Exhibit 10. How Grocery Pickup And Delivery Declined Source: WSJ
What forecasters don’t know, and find impossible to factor into their projections, is whether there will be another wave of the virus and how governments will react
From the energy perspective, the economic data show activity increasing, although at varying paces. Forecasters are assuming these rising trends will continue. What forecasters don’t know, and find impossible to factor into their projections, is whether there will be another wave of the virus and how governments will react. The assumption is that there will not be another nationwide lockdown, but rather shutdowns of local hotspots for the virus. This seems to be the case, as virus outbreaks are surging in a handful of states, forcing governors to pause or back-off in re-openings. While this pattern suggests a slowing in the pace of recovery, it likely won’t derail the recovery entirely.
There are numerous claims being made about what the long-term energy recovery will look like. One of the most recent views was in a recent interview with Bernard Looney, CEO of BP plc., conducted by the Financial Times. In February, Mr. Looney, in his first public session with investors and the media after being selected to head the company, announced his new management team and pledged that BP would become net-zero in carbon emissions by 2050, not only for the company but also for the emissions of the BP products burned by customers. With the collapse in energy demand and prices due to Covid-19, the entire future of fossil fuel energy is being questioned as governments figure out how to restart their economies. In Europe, many governments are embracing green energy as a key part of their economic recovery plans. Not only are they considering more solar and wind projects, but hydrogen created from renewables is being tested.
For crude oil, a question has become whether the global economy’s recovery from Covid-19 marks the peak in its use? That question was put to Mr. Looney. His response was:
“BL: I don’t think we know how this is going to play out. I certainly don’t know. Could it be peak oil? Possibly. Possibly. I would not write that off. But there are so many things we don’t control. I genuinely don’t know what the future looks like. All I know is it’s uncertain, it’s going to have volatility.”
Exhibit 11. How Energy World Changed With Virus
Source: EIA, PPHB
How Energy World Changed with Virus
We know neither the IEA nor OPEC sees peak oil in the immediate future, let alone it having already been reached. What does the EIA believe? Using the January, May and June 2020 Short-Term Energy Outlooks (STEO) we can see just how much the EIA has adjusted its thinking about the future for global oil demand. This is how the January forecast differs from the June outlook.
Obviously, in January, there was no consideration of a possible global pandemic, even though we knew of the coronavirus outbreak in China. The lack of China’s honest disclosure about the existence of the virus and the ease with which it could spread, kept it off energy forecasters’ radar screens. In all fairness, unless the status of Wuhan had been prominently highlighted, the virus wouldn’t have been factored into any forecasts as early as January. No one would have understood or appreciated the magnitude of the response necessary to tamp down the spread of the virus. Thus, comparing the June forecast against January’s yields the best estimate of the impact of the virus on the future for oil.
What is interesting is to appreciate how sharply oil demand collapsed during the economic shutdown, and now how rapidly it appears to be recovering. That becomes clear when only the monthly differences between the forecasts is shown.
No one would have understood or appreciated the magnitude of the response necessary to tamp down the spread of the virus
Exhibit 12. Magnitude Of Lost Demand Due To Covid-19
Source: EIA, PPHB
Magnitude Of Lost Demand Due To Covid-19
While guesses about the magnitude of demand in April, May and June are easier to make, the demand recovery in the remaining months of the forecast period is more difficult to project. What we see is that the EIA expects meaningful monthly demand increases through the balance of this summer, but then demand growth remaining stable to the end of 2020. In 2021, a small demand increase is forecast for the first couple of months before leveling off for the balance of the year. By the end of 2021, however, oil demand is projected to be roughly 4 mmb/d below the pre-Covid-19 forecast.
As a reflection of how rapidly the oil market is changing, according to the American Petroleum Institute, U.S. oil demand in May was 16.2 mmb/d, which was 20% below demand in May 2019. However, it reflected 2 mmb/d of additional demand than in April, for a 14% gain. That was the largest percentage increase for any month since December 1975. More than 80% of the increase came from gasoline consumption, as the gradual loosening of the stay-at-home orders to prevent the transmission of Covid-19 allowed people to return to work and to begin driving more. While the U.S. experience was remarkable, it mirrors what was happening in other countries around the world, depending on the status of their reopening. That is the easy part of the forecast. The harder aspect is figuring out the future trajectory of demand.
While the April/May improvement is noteworthy, we examined how the STEO forecasts for May and June changed in light of the initial recovery data. Presumably, the EIA forecasters were factoring this improvement into their June projections, but what did they do with the later month demand estimates?
More than 80% of the increase came from gasoline consumption, as the gradual loosening of the stay-at-home orders to prevent the transmission of Covid-19 allowed people to return to work and to begin driving more
Exhibit 13. Forecasts Reflect Changing Assumptions
Source: EIA, PPHB
Forecasts Reflect Changing Assumptions
What we see is the demand estimate for the first half of 2020 was greater in the June STEO than what was assumed in May. That improvement appears to disappear during the second half of 2020, likely reflecting expectations for slower economic recovery involving oil-consuming activities such as flying, commuting, and goods shipments. At the same time, oil demand during the latter three-quarters of 2021 is now expected to be somewhat stronger than forecast in the May STEO. Does this reflect EIA’s assumption that some of the weaker energy-related activities they foresee during 2H2020 will rebound in the second half of 2021?
Just as in the IEA’s revised outlook, the EIA sees a similar pattern of demand decline in 2020 and a strong rebound in 2021. The EIA wrote in the June 2020 STEO: “…consumption of petroleum and liquid fuels globally will average 92.5 million b/d for all of 2020, down 8.3 million b/d from 2019, before increasing by 7.2 million b/d in 2021.” The EIA’s 2020 demand decline is slightly greater than that forecast by the IEA (8.3 vs. 8.1 mmb/d). However, 2021 is a different story, as the IEA only sees a 5.7 mmb/d growth in demand compared to the EIA’s 7.2 mmb/d increase.
The difference between the growth estimates for the two forecasting agencies is equivalent to the average historical annual demand growth. We suspect the difference in the 2021 demand outlooks reflects minor variations in the assumptions about what will drive oil consumption activity. It is those assumptions and their differences that will prove critical in predicting long-term future oil demand. We have attempted to provide some perspective on what might happen, without assuming significant lifestyle and work changes. Not everyone forced to work from home during the shutdowns will continue to do so. They may not venture to their offices every day as before, but they won’t remain cloistered at home. Commuting will return, and initially it could have a greater impact on gasoline consumption, as people opt for driving rather than taking mass transit.
Exhibit 14. We See Less Oil Use Long-Term Than The EIA Source: EIA, PPHB
We See Less Oil Use Long-Term Than The EIA
If we consider where our long-term forecast is compared to the EIA’s outlook, we see a gap in demand of 2.3 mmb/d in 2025. While some might quibble with us. They expect demand to be back on the long-term growth path projected by the EIA by 2025. We note that airline and travel executives are predicting it will not be until 2023-2024 before air traffic returns to pre-Covid-19 levels, so a little slippage in their projections seems entirely possible. While that remains a guess, we would also point out that the planes flying in 2025 will be much more fuel-efficient than those hauling people around the world last year. That will reduce potential demand.
By 2025, corporate supply chains will also be remade, which is likely to translate into less globalization. Previously, we showed the long-term seaborne trade forecasts by Martin Stopford, director of research at shipping consultant Clarkson Research, based on three different outlooks for Covid-19.
How Seaborne Trade May Evolve In The Future
Exhibit 15. How Seaborne Trade May Evolve In The Future
Source: Martin Stopford
Under the scenarios, Trend represents a return to the historical growth rate for seaborne trade of 3.2% per year after resuming growth in 2022. The Slump sees the downturn extending out to 2024, as trade falls by 17% during that phase. Afterward, oil and gas trade growth falls to only 1.5% per year. Bulk trade actually contracts, while intra-regional container cargo grows much faster. Overall, seaborne trade grows at 0.7% out to 2050. The Soft scenario projects trade growing 2.2% per year, after declining by 1% over 2020-2024. We tend to favor the Soft scenario as being more representative of how we believe global trade and relative economic growth will unfold. At the same time, we know that the carbon emissions policies impacting shipping’s fuel choices is likely to knock 25% off shipping’s 4 mmb/d fuel consumption in 2019. This demand loss will come from both more efficient energy use by newer ships, but also the introduction of alternative fuels such as liquefied natural gas and batteries for coastal routes.
The declines in the amount of fuel used for air travel and shipping can explain our long-term demand forecast shortfall compared to the EIA’s projection. That decline is before we consider potential demand erosion from increased penetration of electric vehicles in the transportation sector.
There is little doubt oil demand will not be what forecasters predict – including us. The odds, we believe, favor the differences being to the downside. Will the differences be materially greater than we foresee, or less? Only time and additional information about the recovery will provide the perspective to judge oil’s long-term outlook.