21 April 2020
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No one knows how the oil price crash and coronavirus crisis will play out for the green economy, but the stakes could not be higher
Few sectors better illustrate the truism behind the old Niels Bohr adage that it is difficult to make predictions, especially about the future than the oil industry.
If you had posited a couple of months ago - even as concerns about a mysterious and highly contagious virus were escalating and the US, Saudis, and Russians were at each others' throats over production levels - that oil prices would go negative before April was out then, well, you could have made a fortune investing in oil storage capacity, couldn't you?
But few did and now we can add the 2020 oil price crash to the 1970s oil shock and the periodic gluts and shortages that have characterised late capitalism's apex commodity for decades. In fairness, this time is different. Negative prices are genuinely unprecedented and they provide a glaring signal as to quite how bad the economic crisis is fast becoming. Then again, we are living through an unprecedented crisis. It would be strange if the ultimate bellwether product did not tot up a few unprecedented feats of its own.
As such, it is important not to overstate what happened yesterday as US oil futures briefly went negative, sparking further price slumps around the world. A number of factors explain the surreal sight of companies paying for people to take their oil away. As oil analyst Alex Gilbert explained, yesterday's deadline for May contracts meant many oil traders simply had to offload their contracts at any price or risk having to collect oil next month for which they can find neither refineries willing to process it nor storage capacity willing to keep it. Contracts for future months remain in positive, if remarkably low, territory - for now.
Oil is almost down to $1/barrel. Since many are not familiar with oil markets, its important to note why this is happening.
— (((Alex Gilbert))) (@gilbeaq) April 20, 2020
The May contract expires tomorrow. If you have a May contract at expiration, you must take physical delivery of 1,000 barrels of oil at Cushing in Oklahoma
"This is a very concerning development but it does not mean that oil is valueless, yet," Gilbert explained. "The number of actual physical barrels being traded at this prices is very limited. Most of May delivery barrels are contracted in the $20s/barrel and even above. That said, this a terrible sign of what's to come. It's entirely possible that we see sub-$10/barrel spot prices all of May. Negative pricing for spot and futures are also possible for most US barrels."
We are now likely facing a sustained period of ultra-low oil prices with periodic collapses into negative territory. The short to medium-term fundamentals for the market are terrible. There is a record slump in demand with no immediate end in sight and a growing consensus that when lockdowns are eased demand for transport fuels will recovery only slowly and may never return to historic highs if home-working and tele-conferencing become embedded practices. There is a glut of oil with storage capacity filling up fast globally. There is the inherent lag time between oil supply and demand, whereby it costs companies to turn the taps off and on, leaving them to calculate how long they can weather prices that tick below production costs before trying to adjust supplies to the new market reality. And there are the geopolitical tensions both between OPEC and the US and within OPEC itself, which provide the lowest cost producers with an incentive to squeeze the US fracking industry until it collapses under the weight of its financial contradictions.
That said, while the depth of this week's oil price crash is one for the record books, it is not entirely unfamiliar for those with long memories. As former BP boss John Browne told the BBC this morning we've experienced similar price crashes before. "The prices will be very low and I think they will remain low and very volatile for some considerable time," he said. "There is still a lot of oil being produced that is going into storage and not being used. This is very reminiscent of a time in the mid-1980s when exactly the same situation happened - too much supply, too little demand and prices of oil stayed low for 17 years."
The big question is if oil prices stay low for 17 years this time around will they ever recover, given that by 2037 the world should be deep into the three decade-long project to build a net zero emission economy?
Well, predictions are hard, especially about the future.
Nothing about how the oil price crash will impact the net zero transition is clear or certain, and anyone who suggests otherwise probably has a very cheap barrel of oil to sell you. It is possible to make a compelling case for record low oil prices being disastrous for the green agenda and for being a boon for green businesses.
On one hand low oil prices undoubtedly shift price signals to undermine the raw financial case for investment in electric vehicles, energy efficiency upgrades, holidaying closer to home, and so on. Burning fossil fuels is even cheaper than it was before and in a world without adequate carbon prices (narrator: we live in that world) that is bad news.
Moreover, a collapsing oil price gives overwhelmed political leaders yet another industrial crisis to worry about. Many will reach for the blunt object of bailouts for fossil fuel operators in a bid to tackle the short term political risk that comes from mass layoffs from a uniquely powerful industry. In case you were in any doubt as to how President Trump might respond, he spelt it out this afternoon:
We will never let the great U.S. Oil & Gas Industry down. I have instructed the Secretary of Energy and Secretary of the Treasury to formulate a plan which will make funds available so that these very important companies and jobs will be secured long into the future!
— Donald J. Trump (@realDonaldTrump) April 21, 2020
Then again, he used to say much the same thing about the US coal industry and coal plants are currently closing faster than you can say 'he should have been impeached'.
As with coal, clean technologies remain well positioned to win out against oil in the long term, even if oil prices remain low for a sustained period. Firstly, the raw financials were never the only reason for switching to clean technologies. Plenty of businesses will persevere with their EV fleet ambitions and energy efficiency upgrade programmes, even if petrol and energy costs plummet, knowing that the long term reputational and risk management benefits remain compelling.
Secondly, the nature of the oil price crash only serves to highlight the volatility that defines the commodity, which contrasts so sharply with the predictability and stability offered by many clean technologies. Oil prices may be low, but long term renewable energy contracts and electric vehicle fleets have never looked so attractive to financial directors with an eye on the long term.
As Brett Fleishman of climate campaign group at 350.org observed, the past 24 hours provide "another powerful example of how fossil fuels are too volatile to be the basis of a resilient economy". "It is time for the fossil fuel industry to recognise that, from now on, the cheapest and best place to store oil is in the ground," he told the Guardian. "While this recession shows us that we desperately need sustainable, resilient, and stable economic systems, based on renewable, accessible and just energy sources, the fossil fuel industry is not only trying to profit off of the current chaos, but continues to drive us further into climate breakdown."
Governments that accept the risk posed by that climate breakdown should recognise that low oil prices could finally open up the space for cash-strapped exchequers - and they are all about to be severely cash-strapped - to deliver on their long-standing promises to phase out fossil fuel subsidies and engineer effective carbon prices.
All of this will play into the decisions being taken by the oil producers themselves. Will the Saudis and their allies respond to a sustained slump in prices by recognising the true urgency of the need to diversify their economies, or will they double down on their bet to be the last producers standing? Will those oil majors that have just publicly committed to a net zero transition ramp up their decarbonisation plans or will financial pressures demand a rethink?
There are good reasons to think the former scenarios should win out in both instances. Plummeting oil prices will make investments in new production ever harder to justify, especially as more and more countries commit to net zero transitions. At the same time, as Chris Stark of the Committee on Climate Change argued this morning, the historically low returns on offer from oil projects suddenly look far less financially compelling when set against renewables projects, especially when the contrasting cost curves and proice stability are considered.
Once again, the question as to how the coronavirus crisis and oil price crash plays out for the net zero transition comes down to the choices that are made. As anyone who has picked up an economic text book knows, the oil shock of the 1970s triggered different responses from different countries. As Denmark provided a famed case study by sowing the seeds for the global renewables industry and prioritising energy efficiency investments, many other nations flirted all too briefly with the concept of energy-saving before quickly reverting to their wasteful, carbon intensive ways.
It is now blindingly obvious the world should seize the opportunity to focus recovery plans on turbocharging the construction of cleaner, healthier, and more resilient economies. Savvy governments and businesses have already recognised this and transforming their investment plans accordingly. The big unknown is whether enough of their peers will follow them.
As the world wrestles with the worst economic crisis in generations, it is worth all business and political leaders taking a moment to recognise that the decisions they make in the coming weeks and months could determine the pace and direction of the global net zero transition for decades to come. It is hard to predict the future, but given the scale of the climate crisis, it is no exaggeration to suggest that the choices made right now will echo through the centuries.
