Oil field shutdowns drive the oil price higher

The US Energy Information Administration forecasts decent recovery in US oil output later this year and next – but still below the levels reached in 2019.

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  1. Charles Stanley

In April, global oil demand was down by 25 million barrels a day. Many aircraft fleets were grounded, and many countries in lockdown saw record lows for road transport. The International Energy Agency expects some recovery as lockdowns are relaxed but thinks for the year as a whole there will be a shortfall of 9 million barrels a day in world demand compared to 2019.

The shock to the world's energy markets has been severe. Oil prices slumped, at one point turning negative on stories that the world was running out of storage space to hold the surplus production. Many oil companies announced major cutbacks in their investment programmes, slashed their dividends and stopped their share buyback programmes.

In recent days, the oil price has been on the rise. There are hopes of recovery bringing a bit more demand into play. There are rumours that OPEC and its wider group of supportive countries will extend their current deep cuts to production for longer. It had planned to cut 9.7 million barrels a day of output until the end of June – and is now considering continuing at this level for maybe another quarter.

This would be a 2 million barrel a day larger cut than announced in April for the third quarter. US output too is down sharply. The shale industry soon runs off its production when the price falls. Fracking teams have been stood down. The Baker Hughes rig count for the US is down by a massive 70% compared to May 2019, a fall of 683 rigs.

Investment slump

The International Energy Agency forecasts a fall of $250bn in oil and gas investment this year, with an overall 20% fall in energy investment in total. The combination of marked oil price weakness and the big fall in demand make the outlook bleak for all those involved in exploration and development activities for the oil majors. These forces, of course, allow prices to rise a bit. The huge gap between potential supply and potential demand is being addressed rapidly by these large changes to output, at the substantial cost to the oil-service industry.

The green movement will take comfort from this, and will be looking for ways to lock in the gains as they see them. They are keen to see a permanent and major reduction in the use of diesel and petrol for surface transport and in aviation spirit for planes. They want more goods, food and services to be delivered from local suppliers, they want less overseas travel and a big switch to trucks and cars that work from electricity. It is likely governments, particularly in Europe, will offer tax cuts and subsidies again to promote their green idea. They would be joined by the US were Joe Biden to oust the President in the election.

It seems likely we are now past the worst for the price of oil. It fell so low because the virus-related collapse demand was compounded by a brief supply war between Russia and Saudi Arabia over who was to take the biggest cutbacks. Now it seems Russia and Saudi are working together again, whilst the US is cutting back from market forces at the same time.

Shakeout coming

The US Energy Information Administration forecasts a decent recovery in US oil output later this year and next, but still below the levels reached in 2019. That assumes the industry gets through the next few months of bankruptcies and refinancings leaving sufficient capacity intact – and hopes that enough well-financed companies are ready to drill and develop more oil as soon as the price allows.

Valuing the large integrated oil majors is difficult in these conditions. There will be some price recovery from lows brought on by the dividend cuts and the severity of the lockdown. There also needs to be consideration of what is the longer-term value of their reserves, given political determination in some quarters to leave more of them in the ground.

The Covid-19 collapse and rethinking make oil companies a bit more vulnerable to the changing mood. Some people are pleased to have been jolted into flying and driving less and want to make a habit of it. Others will get on the holiday plane or take the car to work as soon as that is possible.

Meanwhile, the relaxation of the bans and restrictions on flying are coming off in a patchy way at quite a slow rate, further disrupting the summer holiday plans of European and American citizens and delaying recovery in leisure and tourism-based businesses. The US and China have extended their trade war into exchanges about stopping flights from each other’s countries.

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