Foreign Policy Blogs

COVID-19’s Impact on Energy Markets

With COVID-19 spread across the globe and spikes of cases emerging, economies have fallen into recession and energy markets have been severely impacted, bottoming out in April. The global gross domestic product (GDP) in 2020 is now projected by the International Monetary Fund to decline to -4.9%; global GDP in 2019 was 2.9%. Furthermore, historic changes in energy supply and demand has elevated calls for structural sectoral change. The energy industry has been adversely impacted as consumption has dovetailed with restrictions on economic activity and personal mobility enacted to prevent the spread of the virus.

Stable energy markets are essential to have a modern society function smoothly and for sustained economic growth. The COVID-19 impact is a prime demonstration of energy market volatility, which has broad global impact from oil producing nations to net importing countries and various stakeholders in the value chain. The pandemic has emboldened a mounting group of industry voices, advocates for climate policy and politicians to call for a system redesign to create stability of the current energy system and mix.

One of COVID-19’s lasting impacts may be such an energy transition. The impacts could reshape the way people live and energy demand may not return to 2019 highs. Oil majors have lost billions of dollars in revenue. To compensate, British Petroleum, for example, took a $17.5 billion write-down of its assets. Royal Dutch Shell is writing down up to $22 billion of its assets. These actions and market forces will force, for now, broader exploration operations to be slowed and for the companies to build strategies to operate in a less volatile market. BP has previously pledged to achieve net zero emissions by 2050 and Shell details its carbon strategy in the plan it calls Net Carbon Footprint.

Oil as important and volatile as ever

As a result of the pandemic and measures to limit the spread of the virus through mobility and economic restrictions globally, oil consumption has decreased substantially.

World oil demand is predicted by the OPEC to fall by 9 million barrels per day (b/d) in 2020 compared to 2019, which would be a record. In the United States, the Department of Energy’s Energy Information Agency (EIA) forecasts that U.S. crude oil production will average 11.6 million b/d in 2020 and 11 million b/d in 2021, the 2019 average was 12.2 million b/d. However, a historic rebound could follow suit. In 2021, demand is predicted by the International Energy Agency (IEA) to be the largest one-year gain in history by adding nearly 6 million b/d to 97 million b/d.

Crude oil has a long history of volatile price fluctuations but the volatility in April was historic. When demand and consumption plummeted, the market dropped off a cliff. With demand dried up so drastically, there was excess oil. Traders were actually paying buyers to alleviate the glut. The price of West Texas Intermediate futures contracts for May 2020 turned negative for the first time in history bottoming out at $-37. Producers needed to slow their production to ease supply of the liquid to stave off further saturating the market and, as a result, prop up prices.

The global crisis has created circumstances which require collaboration to overcome the unique obstacle. OPEC+, composed of OPEC member countries and other oil exporting countries (Russia chief among those), agreed in April to cut crude oil production by nearly 10 million b/d through July to ease the oversupply and as a contingency to attempt to provide stability for the market. Due to the precipitous drop in demand, there simply was too much oil for the market to absorb, let alone physically store.

As the OPEC+ production cut agreement actions were implemented, United States production was reduced and China and other countries lifted restrictions to “reopen” their economies, a relative market rebound followed suit. The current price of both WTI and Brent Crude has settled around $40 per barrel. Despite the gradual uptick in demand, there remains the uncertainty that the virus may bring another severe shock and consumption will plummet again. The collapse provides an opportunity for a top to bottom evaluation of the sector and examine potential transformations to less volatile markets.

Investment

The precipitous drop in energy demand, reduced earnings from lower prices and bills that will go unpaid by consumers yields shortfalls of tens of billions of dollars for governments and industry. The equation is a recipe for contracted energy investment in 2020. The IEA estimates that investment could drop by 20% compared to 2019, the largest decline in energy investment ever.

Electrify demand reverses course

After years of consumption growth, electricity demand has dropped by more than 20% in some countries as a result of the coronavirus and corresponding restrictions. The EIA predicts electricity consumption will drop 6% compared to 2019 in the United States. Electricity consumption has increased in residential applications, however, the reduction in industrial and commercial sectors, which are larger consumers, have a greater impact on the generation mix.

Renewables See the Light

Renewable energy has been a relative bright spot during the COVID-19, especially the impacts among the electricity mix. Its output is unaffected by demand, has low operating expenses and its costs have been continually decreasing for the better part of a decade making it cost competitive or even cheaper than other energy sources in some regions. In the U.S. the cost of building solar and wind power plants has decreased remarkably by 40% and 80% respectively over the past decade. With decreased electricity demand, increasing the utilization of renewables is sensible as other sources feedstocks can be costly and are subject to volatile markets. As such utilities have been increasing renewable energy uptake and demand for coal has been reduced (natural gas has a substantial role too).

Renewables have made steady progress increasing its presence in the global electricity mix. In 2019 renewables dwarfed conventional generation sources in terms of both capacity additions and investment. Nearly 78% of the net gigawatts of generating capacity added globally in 2019 were in wind, solar, biomass and waste, geothermal and small hydro facilities. Investment in renewables excluding large hydro was more than three times that in new fossil fuel plants, with developing countries now investing more than developed countries – about $280 billion total was invested, according to the IEA.

Natural gas weathering the storm

Oil touches most aspects of economic activity but natural gas plays a vital role as well. Natural gas has not been as adversely impacted as oil thus far. Consumption is predicted to decrease by 4% in 2020 due to the COVID-19 impact but also lower demand thanks to a warm winter. Major gas markets are at the forefront of the fall in demand. Developed markets in Asia, Eurasia, Europe and North America account for about 75% of decreased consumption in 2020. Half of the consumption drop is from power generation. Industrial, commercial and residential sectors account for the other half. The key driver for the global gas market return will be liquefied natural gas exports, however, currently there is overcapacity. In the U.S., the EIA expects that LNG exports will decline through the end of the summer.

Coal Drop Continues

In many developed nations, coal power plants have been phased out or replaced by natural gas or renewables prior to COVID-19. As electricity demand has fallen as a result of the virus, though, the fact that solar, wind and natural gas power plants are cheaper to operate could force utilities’ hand to continue the steady progression of the transition to natural gas and renewables. Coal demand could decline by 8%, with decreased demand for electricity also playing a large role. China’s coal large consumption offsets larger declines in other countries.

Emission are Dropping

Global carbon emissions have been curtailed 8% coinciding with the pandemic, the largest year-on-year reduction ever, according to the IEA. EIA forecasts that U.S. energy-related carbon emissions will decrease by 14% in 2020, another record. To maintain reductions and not just being a result of a pandemic, a rise in clean energy investment is necessary. If economic activity resumes full bore, the reductions may be short-lived as emission may return to prior levels or increase. Energy investment capital is either dried up or waiting on more evidence of new trends prior to sinking any new money in projects. Renewables have been trending in the right direction, though, to harness more investment. Government and companies will need to implement more policies to catalyze investment and to continue the decrease in emissions in an attempt to reach the targets in the Paris climate treaty.

What Comes Next?

With the recovery, however, markets are still pondering how the rebound will be impacted if a sustained uptick in COVID-19 appears in the near-term or months from now with a second-wave and consumption crashes again. Whenever there is a steady increase in investment it is worth pondering where will the money be going? Will the money flow back to oil and gas or will there be a more dramatic shift to renewable energy, energy efficiency, grid modernization and battery storage? Of utmost importance is also to try to understand how consumption patterns may be altered in a new normal if and when the COVID-19 pandemic is beaten.

It is not an option to underestimate uncertainties in all energy markets.

 

 

 

Author

Joe Gurowsky
Joe Gurowsky

Joe Gurowsky focuses on energy, environment, geopolitics, trade, international development and climate related issues. Recently, he worked in Kenya, Ethiopia and Tanzania regarding different energy related programs . Joe has also traveled to Costa Rica, Ghana, the UAE, Germany and Alberta, Canada for aspects of energy and environmental policy.

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