Current State of the Energy Market
One look at the postwar price chart below tells the story – the coronavirus pandemic has led us into an oil price collapse, the like of which has not been seen since 1986 and 1998.
Record Low Energy Consumption around the World
As economic activity has come to a near standstill during the height of the Covid-19 lockdowns around the world, energy demand has fallen precipitously.
- According to analysis from the International Energy Agency (IEA), published in their 2020 Global Energy Review, the first quarter saw electricity demand drop by 20% or more.
- Airlines, a major consumer of jet fuel, have been hit especially hard. Seat capacity has been cut by 70% or more as airlines eliminated scheduled routes or converted any remaining flights into all-cargo operations.
- Demand for gasoline fell as drivers followed stay-at-home orders and commuters began working from home. Traffic on California freeways dropped as much as 55% while Uber reported its ride share bookings were down 80% in April.
Unprecedented Confluence of Events: Sudden Drop in Demand for Oil amid an Energy Price War
The sudden collapse of demand for energy quickly created a crisis of its own: where to store all the oil and gas being produced around the world.
Energy producers began a desperate scramble to find spare capacity to store crude oil –every empty tank, railroad car, or oceangoing oil tanker around the world was soon filled to capacity.
Despite this, major producers Saudi Arabia and Russia continued with normal production levels even as prices were falling, hoping to increase market share at the expense of more costly US shale production.
Things finally came to a head when futures traders began to take into account that operations in Cushing, Oklahoma (home to North American’s oil pipeline hub) might grind to a halt, unable to cope with the excess capacity.
The results were dramatic: Oil futures momentarily went into negative territory – in other words, producers would have to pay someone to take oil off their hands.
No One Wants to be First to Shut Down Oil and Gas Production
You’ve probably heard the old business finance joke, but it bears worth repeating here: “We sell each widget at a loss, but we make it up in volume.”
It’s true, you can’t make money selling product at a loss for an indefinite period of time.
The logical response to the collapse of oil prices would have been to stop production. Yet, as we mentioned above, both Saudi and Russian producers hoped to leverage their lower production costs into greater market share at the expense of American shale oil production, whose extra production steps (due to fracking processes, etc.) make it more difficult to earn a profit when the price of oil drops below $40.
The idea of shutting down wells was especially unpalatable for US shale oil produces, something that producers wanted to stave off as long as possible. Shutting down an oil well is expensive (workers need to be called in to safely cap a well that’s taken out of production), and once a well has been taken out of production, there’s no guarantee it can be reactivated at a later date to produce the same amount of oil and gas prior to the shutdown.
This is especially true for fracked wells commonly used for extracting shale oil and gas. You can think of the fracking processes as something similar to frothing milk for a cappuccino: injecting wells with high-pressure fracking fluids can create a productive well, but once the well has been shut off, it’s hard to “froth” it a second time.
Nonetheless, the US oil industry was forced to start the unenviable task of shutting down oil wells, which, in turn, has led to record job losses across the oil patch.
Has the Energy Market Become a Game of Survival of the Fittest?
Is it fair to describe the high-stakes energy market as a variation on the popular Hunger Games television series, where the lowest production cost producer wins?
Possibly.
The crisis seems to be accelerating some of the ongoing trends that existed prior to the pandemic.
For example, the sudden collapse of demand for energy has been especially tough for the coal industry, which produces a fuel that’s more expensive for electricity producers to use. The IEA’s 2020 Global Energy Review (mentioned earlier) says Q1 demand for coal dropped nearly 8% over 2019. This is bad news for a sector that was eclipsed by renewable energy sources for the first time last year (and renewables are on track to repeat this feat again in 2020).
Renewables are indeed on the rise, with the IEA predicting low-carbon electricity sources* will reach 40% of global energy generation this year, albeit at a lower total for 2020, as the IEA estimate overall electric demand will be down 5% (assuming an economic recovery later in the year.)
*IEA low-carbon statistics include wind, solar, hydropower, and nuclear.
(Some analysts think the uptake for renewables would have been even higher in 2020, but the lockdown prevented many residential solar energy projects from moving forward.)
The IEA forecasts oil and natural gas demand will recover somewhat during the second half of 2020, but annual demand will be far lower, with oil consumption forecast to be down 8% and natural gas down 5% compared to 2019.
In response, proponents of oil and gas in Washington are taking action to help oil and gas companies reduce the cost of domestic production. Federal regulators have proposed reducing lease payments and reducing royalty rates (or delaying payment deadlines) for drilling on public lands. Washington may be looking at making things more difficult for the solar industry as well, such as taking over the regulation of subsidies for solar power from the states.
Lesson from the Pandemic: Major Changes can Happen Quickly
The dramatic reduction in electricity production and vehicular traffic during the coronavirus lockdown has led to unexpected changes over the course of a few short weeks.
Around the world, people are remarking at visibly lower pollution levels: blue skies are reported from perennial pollution hotspots, such as the Los Angeles basin in Southern California, New Delhi in India, and the Po Valley in northern Italy.
During lockdown life, bird songs have become more noticeable thanks to reduced vehicular.
Biking has become increasingly popular around the world as an ideal way to get fresh air and exercise while maintaining social distancing. Unfortunately, this increased popularity means that new bikes are suddenly in short supply worldwide.
The lockdown has led to less welcome changes as well.
Motorists are taking advantage of open roads free from congestion and speeding is on the rise. In a time when accident rates should be dropping, research indicates that there has been an increase in higher-speed accidents. (Street racers performing the underground coast-to-coast “Cannonball” runs have set new speed records with some drivers reportedly driving from New York to Los Angeles in under 27 hours.)
Cleaner air has led to other unexpected, unintended consequences.
For example, it’s thrown a wrench into California’s cap-and-trade pollution credits market. And skies with fewer particulates in the air appeared to have driven temperatures up in certain regions; some meteorologists believe that the monsoon season in the Indian subcontinent and the recent devastating Cyclone Amphan in India and Bangladesh were stronger due to this effect. Forecasters have predicted a strong Atlantic hurricane season for 2020, creating additional uncertainties for energy companies with offshore oil and gas wells in the Gulf of Mexico.
Unfortunately, weather forecasts may have become less accurate during the coronavirus pandemic due to the reduced number of aircraft flights. It turns out that in recent years weather forecasters have become increasingly dependent upon commercial and cargo flights providing real-time data collection of air temperature, pressure, and other atmospheric conditions along their routes.
Environmental activists are encouraged by how quickly behavioral changes in society have led to visibly noticeable reductions and air pollution, and see it as a first step toward creating a greener future.
Are these changes sufficient to meet climate change targets, such as those outlined in the Paris Accord, for example?
Unfortunately, researchers believe that while worldwide emission rates are down significantly (as much as 17% during the height of lockdown), they expect this year’s overall emissions reductions will be significantly less dramatic: somewhere between 5 – 8%. This alone won’t be sufficient to prevent further rises in global temperatures – especially if we quickly snap back to our previous habits.
Consumer Opinion Indicates a Desire for Change
Nonetheless, there may be some long-standing changes in public opinion about the potential for making change happen and a new appreciation for how quickly it can be done.
Opinion surveys around the world indicate that the public is paying attention and drawing conclusions from the lockdown period.
Working from home has not been as difficult as some predicted. And many of us have learned (or relearned) the joys of cooking at home. (Just don’t mention the dishes…)
But what about the future?
In many instances, a large segment of the population responded that they would like to see a different kind of world result from the coronavirus pandemic rather than returning to business as usual. And a consortium of major companies (including the CEO of JP Morgan) is calling for a “green recovery.”
What will the Future Energy Markets Look Like?
As the economy restarts, will the energy markets be changed forever?
Probably so. Let’s take at what we can anticipate in the coming weeks, months, and years.
First, there are signs of current recovery. The Memorial Day weekend was busy across much of America; cell phone data shows people are moving around again as businesses and offices start to reopen. And there are signs of life in the oil market as well: increased demand from driving has pushed the price of a barrel of oil up.
Over the medium term, coal will likely continue its slide due to high production costs and environmental concerns. Meanwhile, the oil and gas industry in the US will need to regroup and rebuild. Shale oil production is undergoing a painful cycle of retrenchment and reorganization, with many companies probably not surviving the downtown intact. Larger, better capitalized companies will step in. New technologies and techniques will also need to be developed to reactivate wellheads that have been shut down during the pandemic period.
Renewables will continue their march as a low-cost producer. Battery prices are coming down, making wind and solar energy production more reliable as a primary energy source for electricity. Innovation continues: Siemens recently introduced its biggest windmill turbine ever, and Elon Musk may select Texas for production of the all-electric Cybertruck. And as workers return to their jobs installing solar projects, we’ll see an increased capacity for renewable energy in 2021. (To accommodate these changes, many energy advocates are calling for increased investment in the nation’s energy grid infrastructure.)
Finally, we may be entering a multi-speed world. Both China and Europe are poised to invest in electric vehicles and renewable energy sources at a greater rate than in the US. While experts are divided on whether we have reached “peak oil” (most say the answer is no), it’s possible that in the decade to come, we will see markedly different energy markets around the world compared to what we have in place today.
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