Oil – Commodity Analysis and Forecast

(Haris Mohammad and Ujan Shrestha)

Being the lifeblood of industrialised nations, oil has become the world’s most important source of energy since the 1950’s. Its products underpin modern society. Notably used for supplying energy to factories, heating homes and providing everyday essentials including plastics, detergents and even medicines. However, the recent shift towards renewable energy and the rise of environmental NGO’s including Greenpeace has resulted in the sector, which was once hugely successful, now struggling during these turbulent times. The Russia-Saudi Arabia oil price war where Brent Crude hit a 20 year low of $12.78, Biden promising to invest $2tn in green energy and the widespread shift towards renewable energy is not looking overly promising for the fossil fuel industry. 

The negative outlook continues with the commodity being traded in the market as a futures contract, making the price highly speculative. As a result, political events and changes in demand and supply can cause drastic shifts in price. Market sentiment also plays a big role with oil futures as the majority of trades are by hedgers and speculators, creating volatility. 

Changing energy industry 

The future of oil, being the primary and most consumed energy source in our society looks to be in serious doubt following the dramatic shift in the world’s energy mix. The evident negative externalities stemming from this fossil fuel amalgamated with increased pressure from environmental organisations have forced governments to commit to a greener and cleaner future, hence the signing of the Paris Agreement in 2016.  

This commitment has also been echoed by heavyweight oil companies such as Royal Dutch Shell and BP (fall in the top 10 companies in the FTSE100 in terms of market capitalisation) who have pledged to become net zero emissions companies before 2050 and have begun to increase investment into renewables. However, their plans to decrease greenhouse gases emissions comes at the peril of oil, which has fuelled the growth and development of the world up until now.  The shift in focus by these companies has outlined the decrease in importance and of oil in the coming decades.  

This has also been magnified by car manufacturing giants who are planning to reduce then eventually  stop the production of new petrol and diesel cars in the coming decades. The state of California has announced a ban on the sale of new fossil fuel powered cars within 15 years. As California goes, so does the nation and as America sneezes the world catches a cold, thus the direction of where the sector is going is evident. Daimler(Parent company of Mercedes-Benz) has committed to making all cars across the portfolio carbon-neutral by 2039, thus a greater emphasis on electric cars. This is also supported by the emergence of Tesla and their fleet of electrical cars which are soon likely to be seen in streets all over the world. 

It is inevitable that the factors listed above will eventually lead to a contraction in demand and consequently a  decrease in the long-term price of oil in the markets. Although the market is very volatile and there is money to be made, the fate of oil in the coming decade seems to have been sealed according to the status quo and the actions of enterprises. This is an ongoing process that has been pending, however it could be said that covid-19 and the pandemic has added urgency to this matter, and thus shortening the lifespan of oil.  

Impact of Covid 19 

Covid 19 saw a huge unprecedented demand drop and had resulted in severe negative impacts to the highly volatile commodity. The stifled demand continued throughout Q1 & Q2 of 2020 with planes grounded and huge players in the airline industry hitting bankruptcy including Flybe and Air Italy. The freight industry also suffered with many hauliers parked as well as border and travel restrictions put in place. 

The pandemic also saw a huge supply shock, with the Russia-Saudi price war leading the headlines. Covid 19 had created high levels of panic and disparity between nations, with the International Energy Agency (IEA) putting a statement at the beginning of March that oil consumption is expected to contract for the first time since 2009. This created geopolitical tension with Saudi Arabia prompting price cuts. Russia was not onboard with this as they believed the cuts to production would allow US shale producers to propel forward. This then led to a huge surplus and a drastic fall in price, with crude oil trading as low as $30 a barrel.  

Since then, OPEC has made record breaking supply cuts of 9.7m barrels a day (≈10% of global supply) between May and June in an effort to stabilise the markets.  

The majority of oil and gas producing companies saw significantly weaker product demand going into 2020, with Chevron Corp being the only firm to increase earnings year on year (Refer to figure 1).  

(Source:Offshore-technology

With balance sheets taking a heavy hit, this is bad news considering the oil majors are well known in the public markets for their high yield dividend payments. This may be the only strategy to continue the public investment, and a rather dangerous one if demand doesn’t pick up, leading to long term negative implications for its share price going forward. 

 
Biden Victory? 

With the US being the largest consumer of oil in the world, totalling 19.4 million barrels per day, it’s not surprising that presidential elections can have major impacts on commodities. This holds true with the current and contrasting views of Trump and Biden regarding oil. The Democrats (currently favourites in the polls) have earmarked $2tn in spending towards green energy in an attempt to save significant costs long term, increase technological progress and the devastation of the pandemic. Biden is also committed to re-joining the Iranian nuclear deal and the Paris climate accord as well as placing a drilling ban on federal land, which could threaten US consumption, increasing imports and ultimately handicapping US progression in the industry. 

Outlook 

Short-term 

The lack in demand seems to be continuing, as there has been a significant rise in covid-19 cases in many countries. The risk of national lockdowns, or smaller regional lockdowns will continue to keep demand for oil low. This drab demand has already dragged the price of oil below $40 as of 2nd October, and it may continue to decrease further. 

Furthermore, the American presidential election outcome is bound to have a huge impact on the price of oil. Donald Trump stated that Biden will ban fracking, and Biden’s commitment to a greener future has not made him popular with people associated with the oil industry. Biden may have the upper hand as Trump contracted coronavirus and was admitted to hospital. This will affect his campaign trail with the voting day soon approaching. His dismissive approach to covid-19 has come back to haunt him, and this may cost him crucial votes. Biden has already stated that the USA will enter the Paris agreement again, and he has said that he will re-enter the Iranian nuclear deal treaty and remove trade sanctions on Iran, hence encouraging Iran to increase oil production, which may also be met by an increase in Oil production by their geopolitical rival and fellow OPEC member Saudi Arabia. Supply may be excessive, considering that the pandemic has halted a progression in demand. Therefore, prices may continue to decrease. 

Despite the result of the election, oil production may increase as  Saudi Arabia is poised to reverse its extra production cut and bring that 1m b/d of production back due to oil rebounding from $20 to $40. Other OPEC countries will also slowly increase their production, and this combined with the lacklustre demand in the status quo will definitely mean that price will decrease.  

 
However, there will still be demand for oil once the severity of the pandemic eases. Air travel and vehicle transportation will increase, therefore even though there is a possibility for the prices to fall, they will rebound as oil is an affordable energy globally, and despite the environmental concerns , it is too important to fail in the short term. 

Long-term 

Although its usage is secured in the short term, the shift towards renewables in the long term and the innovation in battery technology will seriously undermine its future importance.  

The change seems imminent now with the shift in focus from fossil fuels to renewables being backed by investors. Clean energy group NextEra surpassed ExxonMobil (6th biggest in the world) in market capitalisation.  

(Source: Financial Times) 

Also shown in the graph above; NextEra has been less affected by the pandemic, when comparing the percentage decrease in market capitalisation. The smaller setback in comparison will allow them to continue attracting investors and continue to increase their market capitalisation. ExxonMobil along with other oil majors will have to invest into renewables, as they will be aware of how the market is changing. This means that oil will be replaced by solar, wind, hydro power sourced energy. Therefore, the non-renewable fossil fuel may not have a seat at the energy sector table in the long-term. 

The progressive shift in infrastructure towards green energy can also be shown by the decrease in gasoline demand growth. The graph below shows a decrease between the period 2013-19 and 2019 onwards by approximately 80% in barrels per day. We believe that this trend will continue further due to the emergence of clean energy group companies, increased investment and innovation in renewables and the added concern of the negative impact it is happening on the environment. 

Concluding remarks 

The oil market is bearish currently due to the lack of demand as a consequence of the pandemic. This may continue due to the deterioration of the situation and may be affected further by the increase in supply in oil due to the slow reversal of the OPEC production cut, and the American presidential election. The prices for oil have fallen below $40 and is likely to continue to fall.  

Speculation of the prices in the future markets will also impact the current price, and a Biden victory will surely dampen the recovery $60 per Brent crude oil barrel pre-pandemic price. 

Industry Jargon 

B/d – Barrel of oil produced per day. 

Bearish– Downwards trend in the market. 

Brent Crude – Brent Crude refers to any or all of the components of the Brent Complex, a physically and financially traded oil market based around the North Sea of Northwest Europe 

Fracking – Proven drilling technology used for extracting oil. 

International Energy Agency (IEA) – The International Energy Agency is a Paris-based autonomous intergovernmental organisation established in the framework of the Organisation for Economic Co-operation and Development 

OPEC -  Organisation of Petroleum Producing Countries. International Cartel consisting of 13 nations,with Saudi Arabia the de facto leader. 

Paris Agreement – The Paris Agreement is an agreement within the United Nations Framework Convention on Climate Change, dealing with greenhouse-gas-emissions mitigation, adaptation, and finance, signed in 2016. 

Bibliography 

Brower, D, Raval, A, and Sheppard, D. 2020. Opec Secures Record Global Oil Cuts Deal Under US Pressure. [online] Available at: <https://www.ft.com/content/01dd5ae4-16b9-4c20-becc-6a08c6289a67&gt; [Accessed 3 October 2020]. 

Brower, D. 2020. US Oil Groups Grow Less Fearful Of A Biden Presidency. [online] Available at: <https://www.ft.com/content/22aea330-7614-487e-b282-b41438746249&gt; [Accessed 3 October 2020]. 

Brower, D., 2020. Biden Gambles On Placing Climate Change At Heart Of US Energy Policy. [online] Ft.com. Available at: <https://www.ft.com/content/2ac477e7-34a4-4c0e-b9f4-018cef47d67d&gt; [Accessed 3 October 2020]. 

Brower, D., Sheppard, D. and McCormick, M., 2020. The Oil Sector’s Bumpy Road Ahead. [online] Ft.com. Available at: <https://www.ft.com/content/50764b35-9b68-4894-8a7c-d610c8ee568f&gt; [Accessed 3 October 2020]. 

Jack, S. (2020). Why oil is still the most important price in the world. BBC News. [online] 22 Apr. Available at: https://www.bbc.co.uk/news/business-52382552

Meyer, G., 2020. Clean Energy Group Nextera Surpasses Exxonmobil In Market Cap. [online] Ft.com. Available at: <https://www.ft.com/content/39a70458-d4d1-4a6e-aca6-1d5670bade11&gt; [Accessed 3 October 2020]. 

Offshore-technology.com. 2020. Big Oil Q1 2020 Earnings Plummet Amid Market Chaos. [online] Available at: https://www.offshore-technology.com/comment/big-oil-q1-2020-earnings/?utm_source=Army%20Technology&utm_medium=website&utm_campaign=Must%20Read&utm_content=Image 

Raval, A. 2020. Shell To Cut Up To 9,000 Jobs In Effort To Shave $2.5Bn In Costs. [online] Available at: <https://www.ft.com/content/04a3dde9-aa88-47c5-9d92-ffab6865ddbf&gt; [Accessed 3 October 2020]. 

Raval, A., Sheppard, D. and Brower, D., 2020. Saudi Arabia Poised To Reverse Extra Production Cuts As Opec+ Meets. [online] Ft.com. Available at: <https://www.ft.com/content/9985dc57-708e-4c4a-ab65-0e3c4c6d74cd&gt; [Accessed 3 October 2020]. 

Sheppard.D. 2020. Oil Dragged Under $40 By Drab Demand. [online] Available at: <https://www.ft.com/content/e5d144f6-a587-430d-b1de-9d706c1e41d3&gt; [Accessed 3 October 2020]. 

Statista. (n.d.). Countries with the highest oil consumption 2019. [online] Available at: https://www.statista.com/statistics/271622/countries-with-the-highest-oil-consumption-in-2012/#:~:text=The%20United%20States%20and%20China [Accessed 3 Oct. 2020]. 


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