Oil: the Perfect Storm

By Gwynne Dyer

For the global oil industry, it has been a double whammy. First a foolish price war between two of the world’s three biggest producers, Russia and Saudi Arabia, drove the price per barrel down from almost $70 in early January to under $50 in early March. They were fighting each other for market share, and they were also hoping that lower prices would kill off US shale oil, whose production costs are higher.

Then the second whammy: the Covid-19 lockdowns that started spreading across the world in early March cut total demand for oil by 30% in the next six weeks. By last weekend a barrel of ‘Brent crude’ was selling for only around $20. (There are two oil prices: ‘West Texas Intermediate’ mainly for US oil and ‘Brent’, always a few dollars higher, for the rest of the world.)

Actually, on Monday the US oil price briefly dropped another $60, to -$40, because demand has dropped so far below supply that the world is running out of places to store the excess oil. The producers can’t just pour it on the ground and it’s very expensive to shut wells down, so they’ll pay somebody who still has storage capacity to take it away.

This is currently a problem mainly for inland producers in the US, Canada and Russia, because they are far from the ports where you can still hire supertankers (for up to $350,000 a day) to store the oil offshore. But that cannot be a long-term solution anywhere, so we are starting to see productive wells being ‘shut in’ (closed down) because that’s cheaper than paying for long-term storage of unwanted oil.

This solution has two drawbacks. One is even if the smaller oil producers don’t go bankrupt (they generally carry high loads of debt), their leases will cancel quickly if they stop producing oil. The other is that it will be too expensive to reopen many of the shut-in wells unless much higher prices return – and if they stay inactive for years, the production flow may be permanently impaired.

Last week’s agreement between all the major oil producers to cut oil production by 20% by the end of June does not begin to address the glut of oil. Global production, at 100 million barrels per day (bpd) last month, will fall to 80 million bpd in the next two months, but global demand is already down around 70 million bpd.

Nor is there much hope in sight. Oil demand may drop further, and even in the long run it may never return to pre-January levels. "This is very reminiscent of a time in the mid-1980s when exactly the same situation happened – too much supply, too little demand, and prices of oil stayed low for 17 years," said John Browne, the former head of British Petroleum.

‘Peak oil’ ceased to be a subject for debate some time ago. More and more countries are committing to net zero emissions by 2040 or 2050, and everybody knows that quite a lot of oil (and coal and gas) will be left in the ground forever. So the topic of concern for the industry is now ‘peak demand’ – and some industry analysts think that it is already past.

"The virus will bring forward peak demand for fossil fuels," Kingsmill Bond of Carbon Tracker told The Guardian three weeks ago. "Peak emissions was almost certainly 2019, and perhaps peak fossil fuels as well. It will be touch and go if there can be another mini-peak in 2022, before the inexorable decline begins."

So the stock market valuations of most oil majors have halved since January, and the ‘golden dividends’ of 20% or more are gone forever. The rate of return on new oil and gas projects is now about the same as on wind or solar power projects, so where is the smart money going to go? Oil is ‘low return, high risk, high carbon’, so don’t touch it.

This collapse of production and investment in the industry is hard on the millions of people who make their livings from it (including some entire countries), but the writing has been on the wall for some time now. The sensible and humane course is to support them as they seek different ways of making a living, but climate, not Covid-19, is the real crisis of our time. The jobs cannot and should not be saved.

As for the investors, they deserve little sympathy. They are paying the price of not reading the writing on the wall. The real trick in all forms of gambling is knowing when to pick up your winnings and walk away from the table.

And the real question is: what does the decline of oil mean for our civilisation’s prospects for dealing with climate change without a global calamity? That, however, is a subject for another article.