This oil crash is not like the others

Shell cuts its dividend for the first time since the second world war. Oil prices turn negative in the US. Supertankers of unwanted fuel stack up in the Singapore Strait.

The Covid-19 pandemic has scared the global economy to a standstill, slashing demand for the hydrocarbons that to this day are its main source of energy.

As travel restrictions begin to ease and production cuts kick in, oil prices are edging up from rock bottom. But this is not just another cyclical downturn. It is a savage blow at a time when fears of climate breakdown call the whole basis of our energy system into question.

The majority of the world’s oil and gas reserves must stay in the ground, unburned, to stop dangerous global heating. While few in the industry grasp the scale and speed of transition required, oil majors see the writing on the wall.

Will the current oil market turmoil hasten or hinder the shift to clean energy sources? Do governments need to play a more active role in managing production? What, ultimately, does this mean for the climate?

Producers are drilling less, pretty much everywhere.

The Organization of Petroleum Exporting Countries (Opec) last month struck its broadest and deepest deal ever with non-members including Russia, to reduce global output by 10%. It was not enough to match the slump in demand, but put a floor on how low prices can sink.

Further production cuts will be market-driven. IHS Markit forecasts a drop of 17 million barrels a day worldwide in the second quarter of 2020.

Jim Burkhard, head of oil markets at IHS Markit, said of the analysis: “All producing countries are subject to the same brutal market forces. Some will be impacted more than others. But there is nowhere to hide.”

Extraction is on pause across much of Canada’s tar sands, one of the most carbon intensive sources of oil. US shale frackers are not putting up any new rigs, with many debt-laden small players expected to go bust.

US supermajor Exxon Mobil cut 30% off its capital spending programme. Loathed by activists for its decades-long disinformation campaign on climate change, the once mighty corporation is losing its shine with investors, too. Its stock has declined 10.8% in the past decade, Bloomberg reports in a scathing catalogue of the company’s misjudgments. 

Less oil extracted means less oil burned means lower greenhouse gas emissions. There is an increased risk of polluting methane leaks from abandoned wells and some Russian companies have said they might prefer to pump and burn unsellable oil than cease production. On balance, though, the immediate impact is good for the climate.

Historically, oil busts have been followed by recovering demand and then price spikes as supply catches up. This time, most analysts are not predicting a return to pre-Covid levels of demand until late 2021, if at all.

Among oil majors, longer term forecasts diverge.

Exxon remains bullish as ever, seeing population growth and economic development driving oil sales up over the next three decades.

European companies, under pressure from climate-conscious governments and investors, are less confident of the outlook for oil. Or to put it another way, more confident humanity can overcome climate catastrophe by switching to low-carbon energy sources. 

BP, Shell, Repsol and Total have set out strategies to reach “net zero” greenhouse gas emissions by 2050. Unlike earlier generations of climate plans, these assume responsibility for the emissions from burning their products, which dwarf those from drilling and refining operations. While none actually measure up to the “net zero” claim, according to the Transition Pathways Initiative, the plans show an acceptance that oil’s share of the energy mix will shrink.

Shell chief Ben Van Beurden, defending a decision to cut the dividend by 66%, told shareholders he did not expect the oil market to recover in the medium term.

BP’s Bernard Looney told the Financial Times oil demand could even have peaked pre-crisis. “I would not write that off,” he said.

The longer oil prices are depressed, the more oil fields will go untapped. Analysis firm Rystad has cut its production forecast for 2030 by 6%, citing deferred investment in exploration.

Renewable energy projects, a tiny fraction of oil majors’ portfolios that historically yielded much lower financial returns than petrol products, now look more favourable. They are largely unpinched in the coronavirus round of belt-tightening.

The International Energy Agency, which has long underestimated renewables, now says they are more resilient in the downturn than fossil fuels.

Carbon Tracker Initiative is calling it: 2019 was “almost certainly” the peak of the fossil fuel era, according to the think-tank’s energy strategist Kingsmill Bond. He doesn’t quite go so far as to say oil and gas have peaked. Coal is assumed to have peaked in 2013; the other fuels may have further to go, but their heyday is over.

“We should not be surprised to see this peak even as we are surrounded by fossil fuels in our daily lives,” writes Bond. “Horse demand peaked when cars made up just 3% of their number, gas lighting demand peaked when electricity was in its infancy, and we had Nokia phones before the iPhone came along.”

The global economy will be reshaped by the response to Covid-19. Many of these changes are likely to keep oil demand down: shorter supply chains, teleworking, health and education services being delivered online.

Others will delay a shift to cleaner energy: principally, people shunning public transport for private cars, to limit their exposure to the disease.

Public attitudes matter: the extent to which air travel rebounds depends on how individuals weigh the heightened health risks against pent-up wanderlust.

More important, though, is the policy reaction. Governments are preparing to inject billions of dollars to revive the economy as the coronavirus threat is brought under control. Whether that throws a lifeline to polluting sectors or boosts sustainable infrastructure and retraining is key.

“Green recovery” is the buzzword among UN agencies, climate-hawk governments, urban planners and sustainable business coalitions.

“If our world is to come out of this [coronavirus] crisis more resilient, we must do everything in our power to make it a green recovery,” said Kristalina Georgieva, head of the International Monetary Fund (IMF), at a virtual conference last month.

As the IMF deploys its €1 trillion lending power, it can demand recipients scrap fossil fuel subsidies or work with petrostates to diversify their economies.

Specific investment decisions will be for governments to take. Green spending options include creating cycle networks, renovating buildings for energy efficiency and rolling out better internet connections.

It is also a moment to reconsider oil policy and how it aligns – or not – with climate goals.

The 2019 Production Gap report found governments were planning to extract 43% more oil and 47% more gas in 2040 than was compatible with holding global temperature rise to 2C – the minimum level of ambition in the Paris Agreement.

If production goes unregulated, the usual market dynamics of boom and bust prevail. Cheap oil weakens the incentive to switch to cleaner technology like electric vehicles, undermining climate policies. As drivers revert to gas-guzzling cars, demand for oil picks up and prices spike, spurring fresh investment in exploration.

“The crisis in the oil market does not mean this is the end of oil and gas, so we need government intervention,” says Laurie van der Burg, senior campaigner at Oil Change International (OCI). A ban on new exploration licences, end to public finance for the sector and retraining or early retirement programmes for oil workers is where she would start.

In the US, the OCI floated the idea of nationalising distressed oil companies and winding them down. It brought them into an unlikely alignment with President Donald Trump, whose administration considered buying stakes in oil companies and imposing production cuts.

The idea was shot down in Congress: shale drillers who had taken on too much debt could not expect a bailout from the Democrats. The White House has yet to muster significant targeted support for the sector, despite Trump’s promise to “never let the great U.S. Oil & Gas Industry down”.

Still, it gives a hint of how constituencies with starkly different motives can have common interests. Managed production cuts, while supporting climate policy, would sustain oil prices at a profitable level and smooth out market volatility.

The oil market crash also spurred Trump into a rare act of international collaboration, as broker of last month’s Opec++ deal.

Petropowers have responded to growing competition from clean energy by pumping as much oil and gas as possible while they still can. Russia and Saudi Arabia continued to aggressively pursue market share as the pandemic lockdown started to bite.

This price war came at a cost. Riyadh was forced to raise taxes and cut spending, unsettling the Kingdom’s fragile social compact. Moscow saw its budget surplus for 2020 turn to a deficit.

A weak anaesthetic for the painful downturn, the Opec++ deal, like international climate cooperation, was hampered by conflicting ideas of how to fairly share the burden.

Michael Dobson, a PhD researcher into the anti-colonialist roots of Opec, argues the deal nonetheless shows Opec’s potential to negotiate an orderly exit from oil.

“Obviously the leadership in most Opec countries at the moment are not that interested in managed decline,” he concedes. But looking at the history of Opec, the idea it could take a conservationist approach is not so outlandish.

Venezuelan co-founder Juan Pablo Perez Alfonso conceived Opec as an ecological organisation, to raise oil prices and deter wasteful consumption. He died in 1979 without owning a car.

“If you want to have a transnational organisation that would bring parties around the table and sit down and allocate oil production in order to meet the market demand but you contract over time… If you wanted to build that from scratch, you would build something that looked a lot like Opec,” says Dobson.

“I do think it’s worth climate people understanding how the oil industry operates and not having an entirely antagonistic relationship to it.”

There is also the small matter of millions of workers worldwide dependent on the industry for their livelihoods.

The trade union movement, primed though it is to defend any job under threat, is willing to talk about a “just transition” away from fossil fuels.

This phrase is vague enough not to scare oil workers, while tacitly acknowledging their jobs will vanish.

“We would all like to preserve those jobs,” says Sharan Burrow, head of the International Trade Union Confederation, “if climate action was not an imperative. We are talking about a transition to stave off an extinction of the human race.”

The consolation prize they are fighting for is early retirement or retraining opportunities for workers and regeneration of communities losing out in the shift to clean energy.

“We cannot avoid the shift away from fossil fuels, the question is the timing and how it is done,” says Burrow. “If people don’t trust in the future, if they cannot see themselves with security, see opportunity, they are going to fight it. We have to make sure people move out of those areas in a way that builds hope, with as little damage as possible.”

At an international level, just transition implies that historically disadvantaged countries should be given some leeway.

“We would like to see rich countries lead the transition and phase out their production first,” says OCI’s Van der Burg, while helping oil-dependent developing countries like Nigeria and Iran diversify their economies.

Many countries have a blind spot when it comes to the impact of oil supplies on climate policy. The UK, for example has one of the strongest carbon-cutting laws in the world, yet maintains a policy to maximise oil and gas extraction from the North Sea.

That is partly justified by sustaining employment in the sector, but as external forces cause heavy job losses, this could be the moment to address the disconnect. In a letter to the UK prime minister, the independent Committee on Climate Change put retraining oil workers in low-carbon industries high on the priority list.

In efforts to protect jobs, the government should avoid “lock-in” of a polluting status quo, it warned: “Support for carbon-intensive sectors should be contingent on them taking real and lasting action on climate change.”

In a briefing call, the Committee’s chief executive Chris Stark said: “We are seeing the impacts of a disorderly transition play out. What we need is an orderly transition.”