John Browne, the former chief executive of BP, has witnessed first hand the ups and downs of the oil industry for more than five decades. But unlike the usual market cycles of boom and bust he believes the coronavirus-linked price crash will serve as a warning for the industry of what is to come.
The pandemic has wiped out almost a third of global oil demand through lockdowns and travel bans, landing a direct hit on a sector already in the grip of its own crisis: how to evolve when climate change has risen up the political agenda, and oil demand is threatening to peak?
The timing of oil’s crash is being viewed by some as a trailer for a summer blockbuster — a faster, flashier version of the main movie, if oil demand really does top out in the next 10 to 15 years. In the past month oilfields have been shut down, storage tanks have filled up in record time and national oil companies even briefly embarked on a price war to try and win a bigger slice of a shrinking market. US prices turned temporarily negative for the first time in history in April, so depressed was demand.
Some in the industry argue that behavioural changes during the coronavirus outbreak will accelerate the peak demand trajectory.
“We’re seeing just how fragile the world is in this pandemic, and awareness of fragility is a very important thing in shaping human behaviour,” Lord Browne says. “People who have spent months worrying about their lungs are more likely to want clean air.”
As oil executives take stock after one of the most disruptive periods in the industry’s history, many are reflecting on how the pandemic will reshape its outlook beyond the need to weather a drop in prices to around $25 a barrel.
On one side stand executives like Lord Browne, who now chairs LetterOne, part owner of independent oil and gas producer Wintershall DEA, as well as sitting on the board of a biomedical institution researching potential vaccines for Covid-19. They believe the world will be changed so indelibly that oil demand will struggle to regain the upwards trajectory that has underpinned the industry for over a century. They see the potential for demand to peak earlier than expected, with a more rapid shift into renewable energy.
For the industry that means growing pressure to adapt their core fossil fuel businesses even sooner.
On the other side of the argument are those who think that efforts to mitigate climate change risk being derailed by cheap oil and a global depression that will suck up so much government time and stimulus money that climate efforts will be pushed aside. In this scenario, investment in the oil industry could fall so much that supply shortages eventually emerge, spiking prices higher.
“We’re right at the beginning [of this debate],” Lord Browne says. “But a health crisis changes people’s attitudes significantly and that will roll up to the oil industry.”
Investors had already turned their back on the sector even before the pandemic struck. They were motivated by fears that demand growth is weakening and the rise of ethical, social and governance-led investing has damped appetites for shares in big polluters. In the US, the value of energy companies on the S&P 500 has shrunk to less than 5 per cent of the total index from 11 per cent a decade ago.
The International Energy Agency had been predicting that global oil demand — which has risen by an average of 1.5m barrels a day each year in the past decade to reach 100m b/d in 2019 — would start to witness slower growth from 2025. Most oil companies believe wider adoption of electric vehicles or stricter regulation on emissions could see demand peak between 2030 and 2035.
Bernard Looney, BP’s chief executive since January, has staked his tenure on a promise to set the company on a path to “net zero” emissions.
The plan, to be fully unveiled in September, is expected to see BP eventually shift faster into renewables like wind and solar, alongside kick-starting measures like carbon capture and storage to offset CO2 emissions from fossil fuel production. But at its heart it has one simple tenet: one of the world’s most famous oil and gas companies is pinning its future on producing less oil and gas.
“The oil industry was already changing,” says Mark Lewis, global head of sustainability research at BNP Paribas Asset Management. “The question is now whether this accelerates [after the pandemic].”
The crash in oil prices from $70 a barrel in January to below $20 in April has not yet knocked BP off course, even if they have had to cut investments as earnings plummet to defend shareholder dividends.
Instead of becoming isolated from his peers by its net zero plan as prices crashed, BP has been joined by Royal Dutch Shell, which announced its own net zero plans in April. “Despite all that is going on, we must keep our eye on the future,” Mr Looney said in a note congratulating Shell’s chief executive, Ben van Beurden, on the move.
Mr van Beurden went a step further last week, cutting the company’s dividend payments to shareholders for the first time since the second world war, and warning it was “hard to say” if oil demand would ever fully recover.
Environmental groups have accused BP and Shell of greenwashing. They argue the companies are not moving fast enough, and point out they still have plans to remain oil and gas producers in the long term.
But Mr Lewis believes their plans go beyond a PR exercise. The economics of the industry are changing, and the second huge price crash in five years has not helped oil’s position. Falling costs mean wind and solar projects work without subsidies, generally providing stable cash flows under long-term supply contracts, with returns on capital invested of between 6 and 10 per cent, according to his calculations. That puts them close to par with new oil projects once oil’s more volatile prices are taken into account.
“The old argument that you can’t generate the same returns from renewables as you can from oil and gas looks increasingly weak,” Mr Lewis says.
The political backdrop for the oil industry is also less stable. Saudi Arabia’s initial response to the slowdown in oil consumption was to launch a price war with Russia, raising its production to maximum levels, partly in a bid to make up in volumes what it lost in price.
While the kingdom has since returned to restricting output, under pressure from US president Donald Trump, analysts believe that could be a portent of national oil companies realising that demand is going to peak sooner rather than later. For Saudi Arabia, which has 75 years’ worth of oil in the ground, the most rational approach may be to pump as hard as possible now.
Jeffrey Auld, chief executive of Serinus Energy, a small oil and gas producer in Romania and Tunisia, says he expects political risk to push larger companies to direct more attention towards less-polluting gas, if not renewables.
“[Companies] have got burnt once too many times with oil,” Mr Auld says. “They’re looking 40 years out and saying ‘well we can’t become like coal’ so they need to move towards something that is more palatable.”
Sam Laidlaw, the former head of Centrica, who now runs private equity-backed producer Neptune Energy, says there are reasons to be cautious about declaring the death of oil. While demand growth could begin to slow, with western consumers less likely to fly as often — German airline Lufthansa has warned it could take years for passenger numbers to return to pre-crisis levels — he doubts the entire energy industry will be able to move as aggressively away from oil.
Just before the crisis hit, the IEA had forecast that jet fuel demand would grow at more than 1 per cent per annum over the next five years, three times faster than gasoline. The economic recovery from the post-pandemic recession may yet favour cheaper, established fuels like oil. “The pressure for decarbonising and doing what we can is just as strong,” says Mr Laidlaw, “but we’ve now got the new problem of affordability [for renewables].”
He argues that more aggressive action on climate change will take greater co-ordination globally, such as the introduction of stronger carbon taxes en masse by national governments. But he sees co-operation slipping. “If we really want to move the green agenda forward we would need to see better global co-ordination. And that hasn’t been there in this pandemic,” Mr Laidlaw says.
In the US, oil majors like ExxonMobil and Chevron have lent support to the idea of carbon taxes, but overall have been slower to embrace the energy transition. Their greater exposure to the high-cost US shale sector has led to an initial focus on cutting capital expenditure. Shale output is expected to decline steeply over the next two years.
Arjun Murti, a former Goldman Sachs analyst who correctly predicted the $100-a-barrel oil era, says the US energy industry is more likely to continue investing in fossil fuels but desperately needs to improve its return on capital to win shareholders back.
Mr Murti, who sits on the board at ConocoPhillips, argues that while he supports climate change efforts he believes estimates of peak oil demand are overblown. Expectations for electric vehicles to curb oil demand are too high, he argues, pointing to the growing uptake of fuel-guzzling sport utility vehicles outside the US.
“Only one company, Tesla, has shown people are willing to buy hundreds of thousands of electric cars,” Mr Murti says. “But that has not yet been proven for other manufacturers. If you look at SUV sales they’ve gone beyond their stronghold in the US . . . cheap oil is likely to exacerbate that trend.”
Chris Midgley, a former chief economist at Shell, says the sector’s biggest problem is that it has performed so badly over the past 20 years. ExxonMobil’s share price is broadly unchanged in two decades. Its market capitalisation — $185bn — was briefly overtaken by Netflix in April.
“It’s the worst performing sector by a country mile,” says Mr Midgley, who now runs analytics for S&P Global Platts. “It is clear that there is going to be less capital and liquidity for the oil and gas industry and people are going to put more cash into the energy transition.”
Some hope that could be the industry’s saving grace after the pandemic. With investors turning against the sector, investment in long-term supplies may fall. Wall Street has soured on the US shale industry’s long-running struggle to turn a profit, despite driving around half of all new supplies globally in the past decade.
If prices remain low and consumption recovers over the next two to three years, and the US shale industry is sidelined, while energy majors focus on the transition, some ask where new oil supplies might come from? “In five years’ time we could be in a very tight market,” says Saad Rahim, chief economist at trading house Trafigura.
Yet higher oil prices might cause more problems than they solve for an industry already fretting about the long-term health of demand. Lord Browne, whose plan to move BP “Beyond Petroleum” 20 years ago was derailed in part by China’s growing thirst for oil, says the supply gap argument will not be repeated this time.
“There’s still plenty of oil around,” he says, pointing to recent large discoveries in Guyana and Brazil. He adds that the US shale industry will not remain sidelined for long if prices recover.
“It is demand the industry needs to worry about, not supply,” he says. “China’s not going to awaken again.”
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He’s not quite prepared to sound the death knell for the industry. He points out that “coal and tobacco companies are still around” and that existing fields will keep running, even if he believes the returns from “plain vanilla” wind and solar farms are starting to look more attractive.
For the veteran of multiple oil cycles, this one, he believes, really is a precursor to the industry’s future.
“The Covid-19 threat feels all-pervading. It’s vivid. Climate change remains a little bit distant from the human individual,” says Lord Browne. “But I don’t think it will remain that way if we don’t do something about it.”
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