Where are Oil and LNG Markets Headed? Corona virus and Its Aftermath

The global energy markets are in a turmoil. The coronavirus impact has already taken a toll on the energy, chemical and manufacturing industries and financial markets. The possibility of a global recession is growing by the day. COVID-19 has affected multiple economies and it is reported that the no. of cases has exceeded 400,000 cases across the world with USA showing a sudden spurt in the past few days. COVID-19 is continuing to spread across countries and each country is putting its best efforts to bring the situation under control. As we see now, 5 major regions are maximum affected - China, East Asia, Middle East, Europe and USA. The govt. in these provinces are taking action on war footing. There are huge implications for the economy, businesses, trade and employment in various countries. Unprecedented impact is seen in the global markets already.  The US stock market lost 20 percent of its value in just 21 days. The scale of impact is much more in such a short period than stock market collapse of 1929 that preceded the Great Depression and crash during recession 2008.

OPEC+ and Failure of negotiations – An Assessment

Crude oil is suffering due to the disintegration of the OPEC+ and the demand slump arising from the coronavirus pandemic’s escalation. OPEC Plus format is in danger because of the failure of the talks amongst the members on additional oil production cuts for rest of the year. The idea proposed by Saudi Arabia led OPEC was to exercise a production cut of 1.5 million barrels per day, starting from 1st April 2020. The support of non-OPEC members is an absolute necessity for this proposal to go through. OPEC had also made it clear that the production cuts will be on a pro-rata basis with 1 Million bbl / day cut to be borne by the OPEC bloc and the balance 500,000 bbl / day cut to be borne by non-OPEC members. But the meeting held in early March between OPEC and non-OPEC allies failed to agree on how much oil production to cut amid the coronavirus outbreak, with disagreement shown by Russia who were not agreeing to the production cut in the context of global slowdown stating that Russia was not totally prepared to approve a further reduction in production. There is also a statement that the OPEC Plus allies could not even agree on rolling over of existing cuts and hence the discussion might continue. 

Russia’s refusal for production cuts has led the market into a frenzy and puts a major question mark on the energy alliance of Saudi Arabia and Russia which grew stronger over the last three years. With demand slump and slowdown being witnessed across countries, the oil demand has significantly come down and hence therefore the price impact is turning out to be catastrophic for some of the countries. Saudi Arabia has said that the cartel would remove all limits on the cartel's crude production - a course of action that could flood an already oversupplied global oil market at a time when demand is already falling. Such an action by Russia is considered as unprecedented and may threaten the OPEC Plus alliance which had worked together for so many years to keep oil prices around certain reasonable levels. While Saudi Arabia and Middle East producers need to have oil prices in the range of USD 60 - 75 / BBL to manage their budgets and economies, Russia may still sustain its economy at prices above USD 45 / BBL. But actually, happened was: Oil prices have fallen to much lower levels with Brent Crude hovering around USD 30 / bbl levels on 25th March, 2020.

The other rationale for Russian action is that a continued lower price at this point in time in the range of below USD 35 / BBL may send many shale oil producers in USA bankrupt and US will face enormous pressure due to further compounding effect of demand and trade slowdown. With US elections round the corner, a major economic storm triggered by Russia, can destabilize the current government and pose fresh challenges to the new government that would get elected – whether it is the current Presidency or new Presidency. While even Saudi Arabia may get benefitted in the medium term if US faces an oil production cut, Saudi’s economy has to absorb a bad negative impact during 2020 which is tricky from their point of view. If the Coronavirus impact prolongs beyond Q2, 2020, even Russia would sink along with Saudi Arabia due to demand slump and this is the greatest risk. 

As far as India is concerned, lower oil prices mean lesser import bill and hence very good for the country from an overall point of view. The government has already announced a domestic duty increase of Rs. 3 / per liter of Petrol / Diesel to shore up its revenues in the wake of fall of crude prices and overall fall in petrol / diesel prices in the country. But the impact on trade and slowdown in some of the key sectors of the economy coupled with major negative impact on countries who are oil producers – like Saudi Arabia, Kuwait, UAE, US, Russia etc – can massively impact India’s trade balance and hence there is a bigger challenge emerging.

Impact on USA

In US, the actions taken against COVID 19 is intensifying. The coming two weeks will see the real impact which can go beyond oil demand and price impact. In 2018, the US consumed 19.96 million barrels per day of crude oil and petroleum liquids accounting for about 20% of the world’s oil consumption, according to the Energy Information Administration (EIA).  China consumed 13.57 million barrels per day during the same year. In US, the impact is getting worse and total panic has set in, resulting in daily household items being out of stock in most stores and online --including hand sanitizer, antibacterial soap, and toilet paper. This is due to preparedness of people to stock up everything in order to face a total shutdown. San Francisco has already announced a total shutdown on 16th March 2020. New York saw exponential rise in Covid 19 cases and is under shutdown. USA, which had shown some strength in terms of economic position during late 2019, has suddenly started facing a major challenge which could have a spillover effect on rest of the world.

That leaves us with the question: Do we really need a price war triggered by OPEC Plus disagreement for a production cut. There is another view which is more scary – There is an opinion that oil demand might fall dramatically by more than 50% across the globe and hence there is a likelihood of a free fall of oil prices. As such, any decision to cut or not cut oil production by OPEC Plus may seem actually meaningless in the context of current developments, triggered by COVID-19 impact.

Of course, fall of oil prices is the bad news for US Shale producers. Technology in US Shale industry is fairly matured now. US shale producers have also achieved optimality in terms of productivity. There is no room for any further efficiency improvement. Therefore, one must take into consideration that even at USD 50 – 65 / BBL oil prices, US shale producers faced pressure. Some of them faced bankruptcy. With oil prices around USD 30 / bbl and uncertainty hovering around and with no scope for further efficiency improvement and cost reduction, US Shale producers are facing darkness down the barrel.

Bernie Sanders, whose Democratic presidential candidate has announced a bill that would shut down all fracking on federal land by 2025 and halt federal permitting of pipelines and LNG export terminals, in his last-minute ditch to become the President. Sanders has also announced that he would phase out fossil fuels in electrical generation and transportation by 2030 and move towards renewable energy on a more serious basis. Net-zero emission is part of the strategy. Though any new government cannot bring the fracking to a halt suddenly due to legal implications, policies to achieve net-zero emissions can slowly but steadily phase shale oil and gas out.

The above shale related decisions are going to be key. US may not allow any new wells for fracking and hence fracking may take place only in existing wells. These wells will last for not more than four years and there will be steep decline in production. Therefore, any such policy will bring down all the shale boom of the past decade to a grinding halt and hence can potentially disrupt the global oil markets. Oil drilling stoppage and LNG terminal closures can suck out jobs and hence a larger economic impact. Can US afford this? Are Russia and Saudi Arabia planning to force US out of oil markets? Big questions to be answered in the coming months. 

U.S. oil industry is entering into one of the toughest phases, leading to a historic crisis. The impact could be far worse than the 2008-09 financial meltdown. US is producing Oil as much as Saudi Arabia. OPEC Plus could not agree amongst themselves to cut production further. So, there is supply overhang and demand reduction, leading to free fall of oil prices, with no OPEC and Russia to hold the prices even in the short run.

On the other hand, there are clear reports coming from US that 50% of shale producers will stare at bankruptcy. A decade ago, the shale industry was a fledgling industry and was almost non-existent. In those times, falling oil prices have helped U.S. economy during periods of crisis by making energy cheaper as US imported lots of oil. With US Producing shale oil today in large quantities, an oil market bust can potentially plunge the country towards recession in a matter of months many industries are getting impacted.

What is in store for Global LNG Markets?

To put the analysis in the right context, Global LNG market has seen a significant jump in LNG trade in 2019. Some of the key highlights are presented below:

1. As per Shell Global LNG Outlook report, total global LNG trade registered a significant growth in 2019, jumping from 319 MMTPA in 2018 to 359 MMTPA in 2019, an increase of a significant volume of 40 MMT. 37% (Almost 15 MMT) of this increased trade of 40 MMT came from USA. USA dominance is expected to continue in 2020. As per the report, long term growth prospects of LNG is enormous and that is reflected in the 71 MMTPA of Final Investment Decision (FID) taken during 2019. Almost 30 MMTPA FID out of the above is taken by USA. Equity LNG is also becoming the post popular way to tie up LNG. 71% of the FIDs taken in 2019, is tied up for off take by the Equity Participants in the projects. This provides an anchor to the project and aids in international financing. Australia is expected to emerge as the largest producer of LNG in 2020 with 82 MMTPA production, surpassing Qatar.

2. LNG demand is expected to double over the next 2 decades. It is forecast that LNG demand will be around 700 MMTPA by 2040. As far as Asia – pacific is concerned, Asia is going to drive the demand growth. China is going to lead the demand surge as its demand for LNG is expected to double from the current 62 MMTPA in 2019 to almost 120 MMTPA by 2040. South and South-East Asia demand will grow by 185 MMTPA. Asia will contribute to almost 75% of the total growth in LNG demand in the next two decades. In fact, the major importers like Japan and Korea are seeing contraction in LNG demand in 2019 and beyond due to larger nuclear availability and milder winters in recent years. China and India will be major drivers of LNG demand in Asia.

But the coronavirus impact and oil and LNG price fall has turned all the forecasts upside down. Mirroring the oil price fall, LNG prices have also fallen. Henry Hub prices fell below USD 2/mmbtu and went down to about USD 1.8/MMBTU.Prices for spot Liquified natural gas (LNG) cargoes imported into Japan, the world’s biggest buyer of LNG, fell in February with the average contract price for spot LNG cargoes shipped to Japan hovering around  USD 3.40 / mmBtu, according to data released by the Ministry of Economy, Trade and Industry (METI), Japan. LNG spot prices fell further to below USD 3 / mmbtu in March.

LNG prices have been hit by a combination of factors - new supply coming on stream in the United States and Australia, a warmer northern hemisphere winter, and the coronavirus outbreak this year that has brought down the demand for all commodities – including oil, gas and LNG. For example, the demand for LNG saw a YOY drop in Feb with major suppliers of LNG to China like Qatar, Nigeria, Malaysia and Papua New Guinea showing more than 30% fall in exports of LNG cargoes to China. 

With falling China and Asian demand and supply overhang, there is going to be an immediate impact on the LNG market in 2020 and there is going to be definite slowdown. Australia supplies to China in large quantities and hence any demand disruption and price fall to such low levels will impact Australian LNG suppliers the maximum. The other major negative impact is going to be on US, whose Shale Oil and LNG industry is going to take a beating during 2020. EU market which generally absorbs excess cargoes is already facing one of the worst economic recession in the history. Forecasting is very difficult under the current circumstances but one can be pretty sure that 2020 is going to be one of the toughest years for LNG.