Energy demand is as good a barometer of global economic conditions as any other indicator. If the International Energy Agency’s forecasts prove accurate, we can forget optimistic projections of “V-shaped” recoveries and look ahead as far as 2023 to regain something resembling a pre-pandemic normal.
In its latest oil market report, issued on Tuesday, the IEA has painted a bleak picture of the state of the energy markets and of the oil market in particular.
It expects demand to fall by 8.1 million barrels a day this year – the biggest fall on record – before rising 5.7 million barrels a day, to 97.4 million barrels a day, in 2021.
That would still leave demand 2.4 million barrels a day short of 2019 levels and, unless there is strong economic growth in 2022, the IEA believes it might be well into 2023 before demand regains those 2019 levels.
The plunge in demand is, obviously, due to the pandemic and the lockdowns of most of the major economies. The IEA places particular emphasis on the plight of the aviation sector, where passenger traffic is expected to be about 55 per cent lower this year than last and the sector believes it will be at least 2022, or perhaps even 2023, before normal volumes return.
The IEA forecasts are predicated on a second-half lift in demand this year as economies start to re-open. Its estimate of June-quarter demand, for instance, was for a fall of 17.8 million barrels a day relative to the same period last year, which implies a solid pick-up in the second half of the year.
That scenario doesn’t appear to incorporate the risk of a “second wave” of the coronavirus in any of the major economies.
The oil price, which traded below $US20 a barrel earlier in the year as the severity of the coronavirus’s economic impacts became evident (and briefly at minus $US37.63 a barrel as the May futures market experienced a meltdown), has stabilised at around $US40 a barrel.
That’s largely due to the recent OPEC+ agreement to cut production by 9.7 million barrels a day to try to bring supply and demand into a better balance. That agreement runs through July but will probably be extended. There have also been significant production declines in the US and Canada in response to the low prices.
The massive build-up in inventories, which have swollen by 1.5 billion barrels this year, will, however, over-hang the market for a long time to come unless the recovery out of the pandemic is a lot stronger than the IEA or most other analysts anticipate.
The prospect of a return to the $US60 or so a barrel price at which oil traded before the coronavirus emerged is also clouded by the potential of the US shale oil sector to rebuild production levels quickly if the price moves much above $US40 a barrel. Shale production has proved to be more flexible and responsive to price movements than conventional oil production.
The expected trajectory for oil demand fits within the IEA’s overall expectations for energy markets.
Earlier this year, while its oil outlook was gloomier than this week’s (a 9 million-barrels-a-day fall in demand this year) it foreshadowed an overall 6 per cent contraction in overall energy demand, the biggest-ever in absolute terms and the largest percentage fall since the Great Depression.
Reduced power generation by industry and a steep fall in road and air transport activity are the drivers of the steep reductions in energy demand.
If energy demand is reflective of economic strength and growth, that implies a smaller global economy over the next few years than was the case before the pandemic.
The glut of oil and the overcapacity in energy production generally produced by the coronavirus will have some structural effects. The energy sector that emerges from the pandemic will be different, and smaller, than it would have been had the outbreak of the virus not occurred.
Earlier this week BP announced it would write down the value of its oil and gas fields by $US17.5 billion in recognition of a permanent diminution of their value flowing from a big reduction in BP’s expectations of long-term oil prices from about $US70 a barrel to $US55 a barrel. It won’t be the only producer taking an axe to asset values and planned investment.
In another report earlier this year, the IEA, which had previously forecast a 2 per cent increase in total investment in energy production in 2020, changed that to a 20 per cent decline in response to the pandemic.
That’s a $US400 billion fall, from $US1.9 trillion to $US1.5 trillion, relative to 2019 and includes a 28 per cent, or $US136 billion, reduction in oil industry investment. Coal investment is expected to fall 8 per cent and even investment in renewables is expected to contract $US30 billion, or 10 per cent.
If China’s exit from its lockdown and the gradual reopening of the US and European economies continue smoothly – and the current Beijing outbreak and the rising infection rates in US states that have begun reopening suggests that’s a big “if” – the combination of demand growth and OPEC+ supply discipline (if it can be maintained) ought to produce a more stable oil market that chips away at the mountainous inventory overhang.
The near- to medium-term outlook even in the best case, however, is for a smaller energy market with less investment in future production and therefore a smaller sector for at least the next several years.
If energy demand is reflective of economic strength and growth, that implies a smaller global economy over the next few years than was the case before the pandemic. If the IEA’s forecasts prove accurate, the more optimistic economic pundits and sharemarket investors will be proven overly optimistic. There is no “V-shaped” recovery in those projections.
Extracted from The Sydney Morning Herald