A bumpy ride: The sharp drop in oil prices following the COVID-19 pandemic has renewed doubts about the future of the sector | Photo: FT

Oil tumbles, will the world capitalise for climate gains?

The global oil industry is going through perhaps its roughest patch in its 200-year history, most of which is marked by growth. While countries representing about 90% of the world’s GDP are under some form of lockdown due to the COVID-19 pandemic, demand for energy, and by extension oil, has plummeted. According to the International Energy Agency (IEA) Oil Market report published earlier this month, 2020 will likely see a dip in demand in the region of 9.3 mb/d (million barrels/day) despite picking up in the second half of the year. This would be close to 10% of the 99.9 mb/d demand seen in 2019. In April, the demand is expected to be nearly 30% lower than 2019 levels, while demand in the entire second quarter is likely to be 23.1 mb/d lower, about 25% lower than the demand at this time last year.

The steep drop in demand has translated to a supply glut that has seen the world run out of storage space. The matter came to a head on April 20 as the US-based West Texas Intermediate (WTI) oil exchange saw prices fall to negative $40 per barrel with some producers paying buyers to take oil off them. The prices have since bounced back to the region of $15 per barrel, which is still much lower than the $50/ barrel that American oil producers see as cost of production. International indices are quickly going the same way. The OPEC+ deal to cut production in order to stabilise prices only managed to briefly stave off the inevitable crash in global prices. Currently, the Brent Crude and the Dubai indices are teetering at just about $20/barrel, a debilitating 70% fall from prices seen at the turn of the year.

The oil price crash is almost certainly going to have implications for climate action. But what that would look like will depend on a number of variables, chief among which will be the nature of the post-pandemic revival. The oil industry’s plight could intuitively point to gains for the clean energy transition. Historically, however, low prices of oil and natural gas could suppress the movement away from fossil fuels in the short term, especially when it comes to power generation and mobility, where transitions to renewables seem the most forthcoming. While low prices could incentivise consumers to delay a switch to renewables, there is also the fear that companies considering a move towards renewables and other mitigating technologies might now defer the move. Further, renewables are also not insulated from the negative impacts of the current pandemic on energy demand and supply chains.

Recessions, such as the one we are currently witnessing, typically cause a temporary contraction in energy demand and associated emissions, only for them to bounce back to their original trajectories in a matter of a few years. But in the longer term, the current price dive is likely to only hasten the gradual weakening of oil as a safe investment. The last sustained decline in the oil industry in 2014-15 did not move the needle on energy transition immediately, but it did give an added incentive for governments to finalise the Paris Agreement the following year. Since then, the renewables industry has only grown and matured, and has begun to be viewed as a stable investment with over $1.2 trillion invested globally in renewables since 2015.

By comparison, oil has been much shakier for investors over the past decade. Investments in oil are now considered riskier and more susceptible to shocks than ever before. Within a decade, oil and gas shares, which occupied 15% of the US stock market, have now fallen to below 5%. Energy analysts have also argued that the current crisis could have very well effected a change that would see oil never again reach the peak levels of 2019. The move away from electricity sourced from fossil fuels in Europe following the financial crash of 2007-08 serves as an apt example. Now, with RE prices down by up to 90% relative to 2008 levels, the probability of a wider transition to renewables is much higher. Analysts also believe that the current shock to the oil sector may end in an “eternal scrappy battle for survival, struggling with overcapacity and stranded assets, with low returns and high risks.”

A similar case can also be made for electric mobility, although auto manufacturers have claimed that low oil prices would make IC engine automobiles much more competitive for the consumer over the lifetime of a vehicle. Despite the fact that electric vehicles are yet to gain investor confidence and maturity seen by RE, running costs of EVs are already substantially lower than ICE vehicles. Additionally, battery costs, which have typically kept the costs of EVs high, have been experiencing precipitous falls in prices, too. Over the past decade, battery storage costs for EVs have been falling by close to 25% year-on-year and are expected to go below the $100/kWh by the middle of this decade. As the sector matures, it is unlikely that consumers gravitate back towards cheaper oil, while ignoring sustained gains made in electric mobility.

The current drop in prices could delay a move among companies towards emission reductions and net-zero ambitions. Oil companies’ stance betrays a more sustained lack of confidence in the sector to continue to enjoy the growth it has seen over several decades. Major oil producers such as BP and Shell have already committed to reducing emissions and achieving net-zero emissions by 2050. Total Oil this week announced that it would cut 2020 capital expenses by 20%, but none of the cuts would come from its “new energy” division, which currently accounts for 13% of the company’s capital spending. A similar position can be expected from other oil majors as investments in fossil fuels rapidly lose sheen amidst the climate crisis, a much larger and sustained existential threat to the industry.

Investment firms and asset management firms, too, have increasingly advocated renewable energy portfolios over oil and gas for lower-risk investments with generous dividends and strong future projections while divesting from the risk-prone oil sector.While transport and power are the two sectors most ready to navigate away from fossil fuels, how the current price crash will impact countries’ fossil fuel demand and emission trajectories hinges on the plans governments conceive for the post-pandemic economic revival. While calls to use the crisis as an opportunity to reduce dependence on fossil fuels have been resounding, there has been increasing support to use the historically low oil prices to formulate taxation schemes that could be put to use to deliver clean energy additions. France has already called for the implementation of a ‘carbon price floor’ for oil that would reflect true costs to the environment. There have also been calls to divert fossil fuel subsidies towards renewable energy, similar to what India did following the 2014 oil price crash, even though subsidies for renewable energy in the country have fallen 2016 onwards because of an increase in competitiveness with conventional energy sources.

This time around for India, which imports 85% of its oil needs, the price crash is mostly a boon as it cuts the import bill significantly. The drop could help check inflation especially at a time when the economy is under the added stress of a pandemic. Sustained low prices could further boost the government’s tax revenues substantially, a part of which could be diverted reducing the dependence on imports. The country has already moved towards expanding oil and gas production in the country, which forms one part of the equation to reduce oil imports. The other part of this equation would be to reduce overall dependence by incentivising and streamlining investments towards infrastructure and manufacturing for renewables, electric mobility and energy storage.

But lobbying for relief packages for the oil industry has also intensified in recent weeks and the case for a bailout only grows when one considers the deep reverberations of shocks in the oil sector on a multitude of other sectors. Governments have a tough choice ahead and prudence would dictate a measured approach that leans towards the progressive and gradual winding down of fossil fuels, even if pulling the plug on the sector is scarcely an option at this juncture.