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Will oil have a future in a post-COVID-19 world?

The volatility and risks associated with oil have historically been well-known in financial markets due to its sensitivity to geopolitical tensions and fears of overcapacity in oil storages. This has been even more evident during the COVID-19 crisis where WTI futures prices went negative for the first time in history.

At the moment, the three biggest factors that have shown to have profound effects on oil prices are:

  • The continuing expansion of COVID-19, which as a consequence continues to deteriorate the global demand

  • The U.S. and China trade war, with China being the largest importer of crude petroleum covering over 19% of total imports as of 2018 (OEC)

  • Tensions among OPEC+ members, which has been seen with the price war between Saudi Arabia and Russia and the compliance issues with many member states (especially Iraq) given that each has different agendas.


However, factors such as the rising interest in renewable energy and policies tackling climate change have been perceived as a too distant and remote to have an effect in the oil market. This is something that could change significantly as this crisis can actually accelerate the energy transition trend and in effect work as a catalyst to restructuring the oil and gas industry. Hence the reason why this can be another factor to consider, which in my point of view, intensifies the bearish outlook for the oil and gas industry in the immediate aftermath of this crisis.

The following are other potential components that may be relevant to consider in order to evaluate the outlook for oil in a post-COVID-19 world.


Behavioural Changes

In comparison to other crises, such as the Great Recession in 2008, the COVID-19 crisis is likely to leave a huge psychological scar and harmful legacy. Although the duration of the pandemic is uncertain it is getting more and more likely that by the time we have found a vaccine then our behaviour and new practices will be completely different from pre-crisis.  Social distancing and home working are almost destined to be the new normality in the near future. In relation to the impact on the oil industry, our increasing usage of video-conferencing services instead of face-to-face meetings can certainly have a profound effect for the future of air travel, which has been one of the biggest sources of oil demand over the last decade. This can be expected to continue due to more reluctant passengers plus the cost and efficiency savings that businesses realise.


In addition, the rising interest of investors in incorporating environment, social and government (ESG) factors into their portfolios and the public pressure of enforcing climate change policies were already taking place before the outbreak. This trend should definitely not be overlooked as this crisis should learn us to be more forward-looking and proactive in dealing with future potential catastrophes.


Deflationary Dynamics

The significant decline in costs of renewable energy over the last decade has made the energy sector more competitive with solar electricity costs per MWh falling almost 86% since 2010. This trend of lower costs for renewables is likely to continue in the future, making it more affordable to different households. Oil and gas could also potentially struggle to compete with the renewable energy industry as public preferences are inclining towards more effective and climate-friendly sources. In addition, it is likely that decarbonisation will remain imperative for the industry and may even accelerate under the current crisis, which could exacerbate the decline of oil demand in the near future.


Risk of Stranded Assets

The risk of stranded assets has been for many years a disputed topic among investors in the fossil fuel industry, with many ignoring this danger due to its perception of being a long-term risk. However, this can shift given that consumer behaviour and demands are likely to dramatically change in a post-COVID world, with a stronger preference towards alternative energy sources that are both more efficient and climate-friendly.


In fact, growing concerns over stranded assets are already materialising among oil and gas companies, with the Royal Dutch Shell and Total each committing to redeploy $2 billion annually of fossil fuel earnings to fund the development of renewable technologies. Stricter regulations and public policies can also exacerbate this trend given that governments have faced increasing pressure when it comes to addressing the negative environmental externalities and can implement several tools such as restricting the activity, implementing carbon taxes or subsidising renewable alternatives.


The pressure of not going back to “business as usual” can certainly be a major difference compared to other financial crises as we start focusing on recovering the global economy. 


ESG

From an investor’s point of view, ESG factors could play a more significant role as a result of this pandemic. Although asset managers have the main goal to construct portfolios that can generate positive returns, more investors will perhaps also be extra interested in portfolios with long-term prospects, that can be resilient to exogenous events and with low volatility. ESG has in many occasions demonstrated to be a good risk management tool and it can potentially reduce the idiosyncratic risk. Taking this into account, it is evident that allocations into crude oil industries would perhaps not be the most favourable due to its environmental implications and high volatility as the chart below indicates.




By Jacob Wesseltoft - BSc Economics & Politics Graduate at University of Exeter


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