Oil as the main asset in the energy resource market

2020-09-18

OPEC’s and BP’s reviews of the energy resource market 16.09.2020Mikhail Hypov

This article will deal with the energy resource market in general, and oil prices in particular. My current interest in black gold is due to the OPEC’s oil market [report][1] published on 14th September, and BP’s [energy outlook][2] 2020.

What are those reports about? How have they affected the current and future oil markets? Is my [June’s long-term crude oil scenario][3] still up to date? Let’s find out!

The article covers the following subjects:

Impact of OPEC’s and BP’s reports

In the chart above we see that the reports didn’t have any negative impact at the moment of publication. Neither did they provoke panics or sales. I marked the period ranging from a few hours before and a few hours after the publication with a red circle. The fall didn’t even update the previous local low.

Panics didn’t affect British Petroleum’s stock chart either, but the local low was updated.

The market impact on the stock quotes was rather positive and held the collapse back. The S&P500 was growing on the reports publication.

I can conclude that these reports’ market effect is overrated, and actually they didn’t play an important role. Another explanation could be the fact that the reports’ main conclusions have already been factored in the prices.

In the chart above, WTI oil prices and the S&P500 were falling at almost the same time at the beginning of September. So what was the reason for the markets’ decline? And what conclusions do these two reports contain?

Contents of OPEC’s and BP’s reports

OPEC’s report didn’t have any surprises inside.

The post-crisis economic recovery period will take more than 1 year. As the table above suggests, the global economy will fall 4.1% in 2020. The outlook for 2021 still looks optimistic. The global economy is expected to grow 4.7%. China will be the main growth driver: its economy suffered the least and kept its positive growth rates. India is the next driver as its economic recovery tempo is expected to cover the damage.

The chart above shows that the 2021 general oil demand growth will be 6.6 million barrels a day, which is less than the 2020 demand slump. Thus, OPEC doesn’t forecast an oil demand recovery next year.

Next, the OPEC experts downgraded the forecast for potential oil demand by 0.4 million barrels a day. It happened following the US Energy Information Administration’s 0.5 million bbl downgrade, so the news wasn’t a surprise.

OPEC’s main concern is the second coronavirus wave, forecasted from September to December 2020, i.e. now. The second wave may be more damaging to the main oil importing countries than expected. In the first place I mean India, China and the Asian region. Analysts believe that the weak low demand may continue in the first six months of 2021.

At the same time, experts singled out another factor that drops oil prices: the growing production in the non-OPEC countries. The USA is expected to be one of the leading producers, with the monthly output rise of 0.12 million barrels.

Despite expectations, low oil prices didn’t fully destroy shale oil production in the USA. The chart above shows that the number of drill rigs plateaued out. So I can conclude that all costly projects have already left the market, and only those are left who can afford to survive amid the current oil prices. In future, these survivors may increase oil output fast. British Petroleum provided a longer-term and deeper analysis of the oil market and other energy resources, which you can check out [here][2].

One of BP’s important conclusions is that global oil demand will never recover to pre-crisis volumes.

British Petroleum’s report includes three scenarios.

Business-as-usual. Implies that the global policies concerning CO2 emissions and non-renewable energy resources remain unchanged, and the current ecological doctrines will be preserved.
Rapid. Implies a set of intergovernmental measures and political decisions aimed at reducing carbon emissions and combating global warming.
Net Zero. Under this scenario, the social behaviour changes in a way that helps preserve environment and is favourable to ecological materials and technologies.

As the chart above suggests, oil consumption is present in all three scenarios up to 2050. However, BP is inclined to choose the Rapid or Net Zero scenarios.

There are several reasons.

1. Global warming

The heat map above shows that only northern countries, such as Canada or Russia, may profit from climate change: glacier and permafrost melting will give access to natural resources and make their production more profitable. On the other hand, even those countries won’t escape such negative consequences as coastal flooding and entire cities’ submergence. The most of the world will be in a great crisis. As all the economies are interdependent, everyone will lose, ultimately.

Bloomberg has conducted an [interesting research][4] into global warming. The interactive map from that research visualizes climate changes in time. Warming by 3 degrees is considered to be critical. Not only will it provoke disastrous floods, but also lead to soil erosion, destruction of relict forests and extinction of animals and plants.

Thus, the society must be ready to assume radical measures to cut CO2 emissions and prevent their negative effects.

2. Negative Covid effect

BP forecasts the coronavirus’ more serious damaging effect than OPEC does. The chart above shows two scenarios in which global GDPs and demand for traditional energy resources and fuel drop. Under the negative scenario where the virus develops in a few waves, the fall doubles. However, the oil demand will have fallen almost 3% by 2025 under the optimistic scenario too. The market’s structural changes explain that effect: the pandemic has changed our lifestyles forever. The remote services are being introduced faster. Business trips became less necessary, while the current technologies allowed organising workspace at home. Thus, the market fell in the areas that can’t be transformed into online services. Transport services are especially susceptible to such changes, and the approach to using individual transport is changing too. People just don’t need to drive often now. Ultimately, it will result in lower oil consumption.

3. Lower cost of solar and wind energy

The chart above shows that these costs will be reducing no matter the scenario. The year 2018 is taken as a reference price. By 2040, solar energy costs will have reduced almost twice, while wind energy costs will have dropped 20%.

Even under BP’s conservative scenario, the share of solar and wind energy will exceed the share of coal or gas power plants. Thus, the demand for hydrocarbon resources will be falling.

4. Changes in transport infrastructure

According to BP’s modest estimations, electric vehicles will account for almost 50% of all transport means. The share of individual cars will drop, replaced by robotaxis and self-driving cars. Hybrid liquefied hydrogen powered vehicles will be developing too.

There’s another trend that affects oil demand: the size of vehicles is getting smaller. The BP analysts say the share of 2-wheel and 3-wheel cars will be growing, and the share of small-capacity engines will therefore be growing too. At the same time, their efficiency will continue increasing, and internal combustion cars will consume less fuel in future. What’s more, gas/oil powered cars will become old-fashioned in 30 years, and oil consumption in the transport sector will drop significantly.

OPEC’s and BP’s main conclusions about the future of the energy

resource market

The main conclusion we can make based on OPEC’s and BP’s reports is that hydrocarbons in general and oil in particular will be consumed much less in future. Regardless of the scenario, the share of renewable resources will be growing while the consumption of hydrocarbons will be reducing.

The market of hydrocarbons is undergoing a serious structural change as well. Coal will be the least demanded resource because the energy resource market of its biggest consumer, China, is being modernised. Natural gas’s position is the most stable. Its global consumption won’t drop by more than 40% even under the most radical scenario.

Another important conclusion is that the US and other non-OPEC countries will increase the production of hydrocarbons and thus compensate for the OPEC countries’ output reduction. This conclusion is logical: the cartel will cut production in order to maintain oil prices. Non-cartel countries, which are not bound by obligations or quotes, will increase oil production trying to claw back the loss related to lower oil prices. Obviously, such an approach will fail, and finally the non-OPEC countries will have to cut oil production too.

Another important conclusion is that the structure of demand for oil products has changed significantly. Under any scenario, the transport sector will consume less hydrocarbons as internal combustion engines will be improving or even fully given up. The only sphere where hydrocarbon consumption won’t practically reduce is chemical industry. It is shown as the grey “Non-combusted” area in the chart above. However, the general situation won’t change. Under the “Rapid” scenario, which is the likeliest, the consumption of hydrocarbon fuel will have dropped twice by 2050.

It will be also interesting to compare BP’s report with last year’s forecasts. The comparative analytics in the chart above says that decarbonization is getting faster. The energy sector is turning to the “green” technologies. In the first place, it’s related to COVID-19 that triggered the reduction in hydrocarbons consumption. The economic growth outlook has been revised. The 2040 global GDP estimate is 8% lower than the value predicted one year ago. The latest forecast has been adjusted for lower oil and gas demand and more frequent use of renewables.

Thus, we can predict the steps that British Petroleum will take in order to modify its business model. The future BP will have to change from the oil production leader to the leader in the power generation and renewables market, in servicing the power supply infrastructure, and in developing service stations, including hydrogen and electric vehicle charging points.

BP’s actual targets:

Oil/Gas production: cut from 2.6 million bbl in 2019 to 1.5 million bbl in 2030.
Electric and renewable power generation: increase from 2.5 GW in 2019 to 50 GW in 2030.

What about other oil-producing giants’ plans?

The headlines of the latest news about BP’s report may seem flashy and revolutionary, but Goldman Sachs [mentioned][5] the energy sector’s decarbonization trend and the market’s structural transition to renewable energy already on 16th June.

According to that report, BP is far from being the leader in business restructuring. The chart above shows the share of funds allocated to the green energy sector, and British Petroleum isn’t in the forefront. One of the first companies that announced a change in its priorities was Repsol. In 2019, it published its goal of reaching a zero CO2 emission by 2050. According to Goldman Sachs’ report, renewable energy development costs will approximate 14% on average, which is more than the expenses associated with the development of new hydrocarbon deposits. Almost all oil producing giants are busy restructuring their businesses in the same way. These are the companies that published a program of full or partial transition to “green” energy:

Total, Shell, ENI, BP, Chevron, Exxon Mobill, Repsol, Equinor, Galp.

How will all these changes impact on the oil market price model? Technical analysis will give the answer.

Long-term forecast for the crude oil market

In my [previous][3] forecasts, I said that the oil market had formed a descending triangle.

In general, it’s set against the historic low of 9.61 USD, from where forms an exit with an upward impulse after the year 2033. Having analysed OPEC’s and BP’s reports, I can say the pattern remains valid, with one exception.

The BP analysts made it obvious that the price has no fundamental reasons for growing sharply from the triangle’s acute angle. On a logarithmic scale, not only is the angle getting narrower, but the pattern itself is changing and turning into a trading channel with almost parallel lines.

Oil production is a costly process, but the cost varies, depending on natural factors, technologies, infrastructure and oil transportation means. Oil prices will be falling together with the demand for hydrocarbons, whereas oil production will be falling together with oil prices. Many oilfields will become unprofitable, and the market supply will drop. It will balance the demand drop, and the price fall will slow down or even turn to a temporary deficit. Thus, the 2021 price pattern suggests a stable downtrend with ascending and descending internal cycles. The BP analysts say that the petrochemical industry will maintain oil demand in the long term even under the most radical scenario. It won’t allow the price to fall to zero. The production of the cheapest oil in the Gulf countries varies from 8 to 10 USD. The price shouldn’t be expected to fall below that level. However, given BP’s long-term scenario, the price will be approaching that level and fluctuating at 10-20 USD for many decades after reaching the price plateau.

In the short term, we must consider OPEC’s influence on prices. Most cartel members can’t accept the price threshold of 25-26 USD, so OPEC will hold back the price above that level by all means. Thus, oil prices will most likely be moving in a range of 25-45 USD up to 2050; the wave pattern will be fading under the buyer’s growing pressure.

Final conclusion

The price is unlikely to return to pre-Covid maximums, according to both the experts and the price charts. Almost all oil producing giants have already started to restructure their business and diversify assets. Obviously, the green wave is already here. Unable to hold it back, the oil companies are trying to get to the forefront of the green energy trend. The companies and countries that haven’t realized that yet and haven’t changed their priorities risk becoming the losers of the race.

My advice about long-term investments is to check whether the companies from your portfolio have got a strategy plan which considers new economic, technological and social trends. Long-term planning isn’t the mere plaything of large corporations. It’s an essential tool and guarantee of sustainable development.

That’s all for now. [Subscribe][6] and keep in touch!

Good luck and profits, everyone!

Best regards,

Michael @Hypov

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The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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momr.opec.org/pdf-download/
www.bp.com/content/dam/bp/business-sites/en/global/corporate/pdfs/energy-economics/energy-outlook/bp-energy-outlook-2020-presentation-slides.pdf
www.liteforex.com/blog/analysts-opinions/commodity-market-analysis-oil-forecast/
www.bloomberg.com/graphics/2020-climate-heat-inequality/?srnd=graphics-v2
www.goldmansachs.com/insights/pages/gs-research/carbonomics-green-engine-of-economic-recovery-f/report.pdf
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