Javier Ramírez

Last dance for the oil prices

Oil prices are on the rise again after trading at negative levels at the beginning of COVID-19 lockdown. The combination of the lack of investments and growing demand because of post pandemic recovery predicts a super cycle in crude prices, but structural social, political, and technological changes make it very likely to be the last one.

April 20th, 2020 was a historical day in oil markets. On that day, the West Texas Intermediate crude traded at negative prices for the first time (around minus $37 per barrel). That was most probably a once in a lifetime event, provoked by the sudden global economic shutdown and the gloomy perspectives about the new reality resulting from the pandemic.

Since the announcement on November 2nd that a COVID-19 had been developed, oil prices showed a steady upward path. These days (July 2021), oil is traded at price levels not seen since October 2018.

Driven by many factors, oil (and gas) is entering a new price super cycle - a long period with prices exceeding the long-term trend, but a series of structural changes of any kind -technological, economic, political, environmental, and social, among others- lead us to forecast that this super cycle will probably be the last one.

We are probably attending to the final act of the Age of Oil that begun in 1901, when the Croatian oil explorer Antun Lučić and Texan Patillo Higgins implemented the first large-scale oil-production facility in Beaumont, Texas. Nobody like Daniel Yerguin has told the history and the story of this age at his Pullitzer Prize winner book The Prize. The Epic Quest for Oil, Money & Power, first published in 1990. A story with an amazing plot and an outstanding cast that extends from wildcatters to oil tycoons like John Rockefeller, to Winston Churchill, Ibn Saud, George Bush, Saddam Hussein, or Hugo Chávez.

In an interview with The Houston Chronicle in October 2020, Yerguin said he takes “the view that it’s probably in the first half of the 2030s that we really start to flatten out and begin a decline (of oil production). Obviously, some people now think it’s going to be a decade sooner than that”.

The current oil rally is the result of the combination of the supply shortage from the lack of investment since 2014 and the demand growth triggered by the recovery in economic activity as the fight against COVID-19 progresses and restrictions are progressively lifted.

Even before the pandemic annual capex in oil business slumped by more than 50% from 2014 to 2019, mostly because of the price war triggered by the entry into the market of crude from new sources as the shale deposits.

In the Summer 2021 edition of International Monetary Fund’s magazine Finance & Development, Rabah Arezki, chief economist at the African Development Bank and a senior fellow at Harvard University’s Kennedy School of Government, illustrated the oil investment crunch with the example of shale oil: “Shale producers have adopted a noticeably more cautious investment posture. As a result, they will be operating with positive cash flows—cash flow was previously directed toward investment spending. This reduced investment will lessen the role of shale as swing production and plants the seeds of a price super cycle”.

The question is if this increase in oil prices will prompt more investment. Socio-political and technological factors may make things different this time.

World powers are committed to decarbonize the economy and the way we produce, consume, and interact with our planet.

At the EU, the Ursula von Der Leyen’s European Commission, with a strong support from the European Parliament, put climate action at the heart of its 5-year policy plan. The European Climate Law, already approved by the Commission, the Parliament and the Council increased its goals of GHG emission reduction from 40 to 55% by 2030.

Europe has committed to increase the weight of renewable sources to 32% of final energy consumption from the current 20%. It also approved the ban of sales of combustion engine vehicles from 2035 and set the goal of a 14% share of electric and biofuels at the transportation sector.

Among the 54 legislative reforms coming from of the Climate Law that should be approved by the end of 2022 is also the reform of the emission trade system that forces companies to pay for the GHG they produce. The rally of CO2 prices in the last year is the best proof that the ETS works for reducing emissions, even at a high cost in terms of higher production costs and electricity prices, that are beating their highest-ever levels.

In the United States, President Biden reassumed the green agenda. His policy package includes the goal to reach 100 percent carbon pollution-free electricity by 2035 and reduce carbon pollution from the transportation sector by reducing tailpipe emissions and boosting the efficiency of cars and trucks; providing funding for charging infrastructure; and spurring research, development, demonstration, and deployment efforts that drive forward very low carbon new-generation renewable fuels for applications like aviation, and other cutting-edge transportation technologies across modes.

China took a significant step when its President Xi Jinping announced last September that the country aims to have CO2 emissions peak before 2030 and achieve carbon neutrality before 2060.

Not only have governments taken the Paris climate accord as their benchmark, but investors have taken it also and companies are now adapting to it partly because investors are demanding it.

Even O&G companies have also decisively started the transformation process towards green energy companies, as the shift away from fossil fuels gains momentum. According to BloombergNEF, they invested almost $60 billion in clean technologies such as wind, solar, storage, hydrogen, CCSU, etc. over the past five years. Even this number would account for about 6% of their total investments in annual terms, it is big enough to illustrate their necessity to transform themselves and dramatically reduce their dependence on oil and gas if they want to survive.

Not only policy making but technological innovation will also make the difference.

Carmakers’ bet on replacing combustion by electric vehicles is huge, which will likely discourage new investment in the oil market. The prohibition of new conventional vehicles in the medium-term horizon has triggered massive R&D efforts at the automotive industry.

Technological changes have also made clean energies generation much more affordable. For instance, the price of solar panels fell by almost 90% since 2006. Hydrogen is called to play a key role in this transformation and the pace of billionaire hydrogen projects is constantly increasing.

It is undeniable, as Arezki states, that “however felicitous a development that will be for the global climate, it poses a risk that the oil reserves so many oil-dependent economies count on will be less valuable (…) That could lead to severe economic woes, including bankruptcies and crises, in turn leading to mass migrations, especially from populous oil-dependent economies, many of them in Africa. Other larger oil-dependent economies in the Middle East, central Asia, and Latin America are also an important source of remittances, employment, and external demand for goods and services that benefit many neighbouring countries. The end of oil, then, could not only devastate oil-dependent economies but could also overwhelm their neighbours”.

There is no consensus on when oil consumption has peaked or even if it already has, but it is clear than structural changes already in place, driven by the necessity of stop harming our climate, point to the end of the Age of Oil. The current super cycle oil will probably be its last dance.