Coronavirus: How will the energy industry react?
01 May 2020
by Michael Bradshaw
In recent weeks the full impact of the COVID-19 pandemic on the energy industry has started to emerge. In a new report, the International Agency predict that 2020 could see global energy demand fall by six per cent, the largest fall in percentage terms in 70 years and seven times larger than the impact of the 2008 financial crisis.
As demand has plummeted, so have prices, the latter exacerbated by a shortage of storage space and the prospect that production may soon have to stop. In early April, OPEC+ agreed deeper cuts than those which provoked Russia to walk away and initiate a price war just weeks earlier. President Trump also sought to orchestrate a wider deal through the G20 to prop up prices and protect the US oil industry. Even before the crisis, bankruptcies were increasing, and the rig count is now falling rapidly with claims of US energy dominance will undoubtedly be damaged, perhaps permanently.
The shale revolution led to a significant increase in oil and gas production in North America, heralding an era of fossil fuel abundance and making it harder for OPEC to manage the global supply. At the same time the 2015 Paris Agreement has created a growing conviction about the need to reduce fossil fuel consumption to constrain global warming below two degrees. That has been married to a rapid fall in the cost of renewable energy and electricity storage.
The combined impact has seen the emergence of a new oil world order that has challenged the dominance of petro-states such as Russia and Saudi Arabia. While we don’t know how long low demand for fossil fuels and oil price wars will last, attention is now turning to support for green energy in economic recovery strategies.
A Green Transition
Most economists predict this pandemic will cause a significantly larger downturn – what the IMF is calling the ‘Great Lockdown’ – than the financial crisis in 2008, more akin to the Great Depression of the 1930s. How individuals, governments and businesses respond to the immediate crisis in the months ahead will have long-term implications, both for the environment and the future of oil-producing nations.
After 2008, there was a rapid rebound in the use of fossil fuels. Within two years we returned to the same path of growing carbon emissions we would have been on if the crisis had never happened. We could aim for a similar quick and dirty recovery this time, putting aside environmental constraints and increasing fossil fuel consumption to get the economy back on track. Alternatively, we can double down on the promises of clean, green growth outlined in the Paris Agreement and treat the recovery as an opportunity to decarbonise our economies.
Great hopes were being placed on COP26, which was due to take place this November in the UK. The ambition was to ratchet up the targets agreed in Paris in 2015. However, that has been postponed, posing huge questions about whether our conviction to address climate change will survive, or become another casualty of the pandemic.
Environmental groups are already lobbying to try to prevent that happening, stressing the need for a Green New Deal in the US and a similar vision in the European Union. If they are successful, demand for oil might never return to the peak we saw prior to COVID-19. For example, there is no guarantee the transport sector will fully recover. After the pandemic, we might have a different attitude to international air travel or physically going into work.
We certainly don’t want to win the battle against COVID-19 only to find that our actions have made fulfilling the Paris Agreement is all but impossible and the threat of climate change is even greater. At the same time, we must not overlook the huge challenges facing petro-states, especially if demand fails to recover sufficiently to support a price for oil that will enable a managed and just transition.
Saudi Arabia and Russia
Together with Richard Connolly and Thijs Van de Graff, I have researched these challenges in relation to Saudi Arabia and Russia. Not only are they the largest oil producing economies, they also hold particular geo-political significance in terms of their relations with the rest of the world.
Saudi Arabia is wholly dependent on oil exports and the revenue they generate but has to come to realise that it must prepare for a world beyond oil. It has its 2030 vision, a programme of reforms to diversify the Saudi economy, creating more jobs outside the oil industry to employ the country’s very young population, and making it more resilient in an age of more renewable energy. This bold plan was to be financed through oil exports during the 2020s. The social cost of oil – the price the Saudi Government needs to balance its budget – is about $80 a barrel, but with revenues currently well below expectations spending is being cut.
To make matters worse, the Government has already spent half its foreign currency reserve, about $500 billion, propping up its budget since oil prices collapsed in 2014. If the social contract, based on the ruling elite distributing oil revenues to create jobs for the young, breaks down there could be serious political and social consequences, causing instability in the Gulf.
Russia is a different type of petro-state, as it has a much more diverse economy, though the Russian Government still gets about 40 per cent of its revenues from exporting gas and oil. Realising that a social cost of $80-100 a barrel was not sustainable, it cut Government expenditure, enabling it to balance its budget at just over $40 a barrel.
The imposition of sanctions also had the effect of isolating Russia from the global financial system and promoting import-substitution. These are both potentially sources of resilience in the current crisis. However, Russia has no vision for a future beyond oil. On the contrary, its recently approved energy strategy is all about developing and exporting more hydrocarbons.
There is a real question mark about the viability of Russia’s economic model going forwards, especially if very low oil prices persist after the pandemic. The latest IMF World Economic Outlook predicts that world economic output will fall by three per cent this year, but then grow by 5.8 per cent in 2021.
But, for Russia, the decline will be deeper – 5.5 per cent –and the recovery more modest – 3.5 per cent. However, all of these estimates may be overly optimistic and some predict a 10 per cent cut in Russia’s output. If that leads to growing political dissatisfaction and social unrest in Russia, it is difficult to predict how President Vladimir Putin might respond, especially as he is currently trying to bring about constitutional reform to extend his period in power.
So, while environmentalists might welcome lower demand for fossil fuels during and after this pandemic, that transition needs to be carefully managed. COVID-19 has left countries such as Saudi Arabia and Russia facing a future in fast forward, with demand for fossil fuels falling far quicker than they anticipated. This will have wider reaching implications for security vulnerabilities, decarbonisation diplomacy, and a changing energy order.
The geopolitics of global energy has already changed significantly from the world of a decade or so ago and energy has emerged as a vibrant arena for geographical enquiry. The immediate challenge is to consider what a post-pandemic (though not necessarily post-COVID-19) world will mean for fossil fuel energy geographies, both in terms of the relative stability of the producer economies and the consequences that could have for the wider process of energy system transformation.
Michael Bradshaw is Professor of Global Energy at Warwick Business School and a Fellow and former Vice President of the Royal Geographical Society. He teaches Managing in a New World on the Full Time MBA programme.
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