The oil and gas industry is experiencing a “truly historic moment”, with prices having dropped below zero for a barrel of oil and liquefied natural gas (LNG) shipments likely to be halted in the near future, says law firm Norton Rose Fulbright US oil and gas practice head Julie Mayo.

She describes the current situation as a revolution, noting that the oil and gas industry has been shaken by several recent challenges, including significant decreases in demand as a result of international stay-at-home orders being issued, as well as a significant oversupply of oil and gas in the near-term.

“This situation is in daily, and sometimes hourly, flux.”

The market volatility began when cases of Covid-19 began spreading rapidly outside of China, with many countries and major cities issuing orders for people to stay at home and cease all non-essential activities.

“This resulted in nearly half of the world’s population being confined to their homes. Many countries have also stopped international flights,” states Mayo.

She says a combination of these factors resulted in demand for oil and gas dropping dramatically. “Estimates are that oil demand dropped by nearly 30-million barrels a day, or 30%, in March. Demand for some refined products dropped nearly 40% in March . . . taking into account how little travel has taken place around the world.”

International gas demand has also been impacted, says Mayo, attributing the reduction to decreased demand for many manufactured consumer goods and power production.

At about the same time as oil and gas demand started to decrease, the Organisation of the Petroleum Exporting Countries (Opec) was shaken by a disagreement between major producers Russia and Saudi Arabia regarding proposed production cuts. “After Russia agreed to a cut proposed by Saudi Arabia on March 6, oil prices plunged nearly 65%,” she points out.

However, at this time, the industry had not yet seen the worst of the oversupply crisis and price decline, Mayo states.

“In mid-April, Opec++ members met in advance of the G20 summit with production cuts being agreed, sufficient enough to at least stem the bleeding.” The ultimate outcome of the agreement between Opec++ and other key parties, including the US and Canada, was to reduce production in May and June by a total of about 15.4-million barrels a day, with 9.7-million of that coming from Opec member countries.

The cut agreed was historically significant, she says. Putting it into context, Mayo says the entire US oil production in February was about 13-million barrels of oil a day, with any surplus going into storage.

However, this oversupply started putting strain on storage facilities internationally. There is a limited amount of storage capacity around the world. The oversupply situation boiled over to the point where effectively all international storage capacity was nearing its limits, with predictions that full international capacity will be reached as early as the end of May.

She explains that such a situation, in which demand continues to decrease and production remains steady, will result in producers having nowhere to store produced oil, at which point they will have no choice but to start shutting down wells.

“The shutting of wells is already well under way in the US.”

For the first time in history, Mayo highlights that, on April 20, the price of oil went negative, “and not just by a little bit, but significantly negative”. During the course of that one day, she says May contracts of physical deliveries dropped by over $50 to -$37 a barrel.

One of the key drivers for this historic slump was storage limitations. “Storage has never been fully committed and is usually under-used.”

She states that the market disruption was not just driven by a drop in demand, oversupply or availability of storage – it was a trifecta of all of these that caused the shock.

NATURAL GAS

While oil was having its historic moment, Mayo says natural gas was also quietly having its own. “The international gas market has also dipped significantly.”

China received its first US liquid natural gas (LNG) cargo in over a year, on April 20. “This may be the lone break for LNG demand right now.”

In addition, European markets are generally oversupplied at the moment,” she notes, adding that there are estimates that up to 25 LNG cargoes from the US alone might be cancelled in the next two months.

Mayo also suggests that natural gas prices may also be influenced by oil price cuts. However, this may increase the price of gas, as demand dips.

FUTURE

The oil production cuts agreed by Opec were not intended to be permanently agreed, she highlights, and are currently scheduled to be rationed down in late summer.

“At the time the cuts were agreed, it was envisioned that demand would rebound and this is consistent with the yearly averages that the Energy Information Administration (EIA) had proposed in its short-term energy outlook.”

However, Mayo states that there is no clear end-point for the current physical distancing and stay-at-home situation, thereby making it impossible to predict when the oil and gas industries will return to normal, and what that new normal will look like.

The industry is hoping for a V-shaped return, where demand returns to pre-Covid-19 levels almost immediately, she says.

However, depending on how long the situation persists, and damage caused to the international economy, she says it will have to be considered that the V-shaped recovery may be more like a U (gradual), or in a worse case a W (persistent volatility) or even an L-shape.

Any potential prediction for market recovery needs to account for cuts in capital expenditure budgets for 2020, notes Mayo, adding that these have recently been in the order of 20% to 30%.

The current outlook is dire with final investment figures on a number of key international energy projects already having been delayed, in some cases by years. “Some oil and gas companies are announcing their first quarterly losses in decades, and some are cutting dividends, in one case for the first time since World War II,” she says.

In the interim, Mayo notes that the industry is experiencing a number of bankruptcies and restructurings, as well as pay cuts and layoffs. “A number of contemplated transactions have been put on hold indefinitely as a result of the current low price environment or the volatility thereof.”

However, she enthuses that all is not gloom and doom - the EIA is forecasting that demand will increase during the course of the second half of this year, and a yearly reduction in demand will “likely not be as dark as what we have seen here today, although it is anyone’s guess really”.

But, Mayo says that with volatility comes opportunity. “Many are hopeful that the current situation may give us an opportunity to rethink our energy needs, how we use resources, and what the energy transition might look like.”