Challenges for Global Oil Stocks

The slump in Brent crude prices to 13-month lows has taken many investors by surprise. The price collapse has had a significant impact on the performance of the large energy names. Shares in sector giants BP, Royal Dutch Shell and Exxon Mobil, for example, have all fallen to multi-year lows in recent months.So, what’s behind the downturn? Not enough demand China is the world’s largest importer of oil and acts as the buyer of last resort. Because of this, any challenges the country faces are severely felt across the energy space. Even before the coronavirus outbreak took hold, demand in China had been slowing. The trade war with the US was already taking its economic toll. However, COVID-19’s additional impact on economic growth has blunted hopes for a near-term demand recovery. As such the oil consumption has plummeted. The International Energy Agency (IEA) expects oil demand in the first quarter to fall for the first time in 10 years before picking up in the second quarter. The agency cut its full-year global growth forecast to 825,000 barrels per day (bpd). Last year, global demand reached a record 100m bpd, driven in part by the needs of the rapidly industrialising emerging markets. The Organisation of Petroleum Exporting Countries (OPEC) had already lowered its demand forecast for 2020 by 19% to 990,000 barrels per day. Too much supply The other important part of the equation is supply. This tends to act as a short-term lever to control volatility that can come from the rise and fall of global demand. In recent years, onshore drilling in the form of US shale had led to the spectacular growth in the country’s crude output. Given the current challenging backdrop, OPEC and its allies, collectively known as OPEC+, are looking at ways in which to better manage their output. If OPEC+ does instigate an emergency meeting, as has been rumoured, and production cuts are agreed, energy stocks should find a reason to rise. Russia is currently evaluating whether to go along with an OPEC+ recommendation to curb output by an additional 600,000 barrels per day. The “energy transition” risk Longer term, the sector is also facing an existential crisis. Economies go through cycles. Peaks in demand are followed by troughs, which in turn are followed by peaks. But what if the fundamental drivers of oil demand disappear? That’s the major debate behind what’s known as the oil industry’s “energy transition”. This is the transformation of the energy sector from fossil-based to zero-carbon by the second half of this century. Climate change has significantly changed the debate and at the heart of the transition is the need to reduce energy-related CO2 emissions. The rise of alternative energy is at the heart of the concern. The challenge to the energy industry is becoming clearer for the financial markets – the profitability risk to existing players coming from disruptive new technology with falling costs and exponential growth. But the oil majors aren’t waiting around. The likes of Royal Dutch Shell and Spain’s Repsol have been leading the charge to adapt. Norway’s Statoil renamed itself Equinor after it decided to become a “broad energy” firm, investing up to 15-20% of annual capital expenditure in “new energy solutions” by 2030. Also, it’s too early to call time on fossil fuels. They will only be doomed if something reliable, affordable and scalable can replace them. That could still take decades. Transport is the largest consumer of oil, accounting for about 60%. This is where the biggest technological changes are emerging. However, we are a long way from electric vehicle technology becoming ubiquitous. Until that time, investment in oil and gas will remain vital even if renewables take up a larger portion of world energy consumption. This is particularly true for crude oil for which supply just keeps up with an annual depletion from producing fields at 5-7%, plus world demand growth averaging 2%. The future of the sector COVID-19 and the slowdown in China represent near-term challenges. It’s difficult to assess what the full impact will be. However, the industry is used to cyclical disruptions and knows how to bounce back from such challenges. However, the shift away from the traditional energy model to one that embraces alternatives is likely to have far-reaching implications for the sector and those looking to invest in the industry. Global warming dictates. Investors will have to keep an eye on how things develop to stay ahead of renewable energy alternatives.  

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