Post-COVID-19 oil market: How to lubricate growth opportunities

OVERVIEW

In April 2020, U.S. oil prices saw a brief but historic plunge into the negative. As the COVID-19 crisis continued to wreak havoc across the globe, travel lockdowns, stay-at-home orders and shuttered factories meant that demand was weakening rapidly. Producers, meanwhile, were racing to cut production to minimal levels.

Struggling to store the sudden surplus aboard expensive tankers, oil producers finally deemed it more cost-efficient to pay buyers to take it off their hands instead. For the first time ever, the world was seeing negative oil prices – the commodity was effectively given away.

“The energy sector has been one of the hardest-hit industries during the COVID-19 pandemic,” Charlotte Watts, Associate Director, Energy & Mining, Aon Asia. “It was also the sector that felt the impact first, with supply chain disruptions leading to an almost immediate change in demand.”

“All companies in this sector have been reminded just how vulnerable they are to global risks, and as we have seen with ‘second waves’ all around the globe, the recovery phase now needs to be flexible, with a plan for additional volatility and risk.”

While uncertainty continues, an unsteady recovery will have a significant impact on the year ahead for the global oil industry. As demand inevitably picks up and the market edges towards recovery, how can oil producers start managing risk and building resilience today to succeed in a post-pandemic era?

IN DEPTH

Other than weak demand, there were numerous geopolitical factors behind the historic low prices the industry saw in April 2020 that began well before the pandemic swept the globe. With the opening of several new U.S. pipelines in the second half of 2019, Texan crude began flooding an amply supplied market, at a time when demand was already suppressed from the China-U.S. trade war.

Price pressure mounted in the beginning of 2020 as COVID-19 swept the globe, further depressing weakening demand as the global economy shut down. Then, in March 2020, prices took a sharp dive with Russia’s refusal to cut production, signalling the end of the three-year OPEC+ alliance. Saudi Arabia responded by driving prices even lower, triggering an all-out price war. As the economic effects of COVID-19 took hold, the volatile market collapsed under the weight of weak demand combined with a global price war.

Future-proofing the energy sector

Devastated by the impact of the pandemic on economic activity and travel, crude oil prices at the end of 2020 had dipped to just half of what they were at the start of that year. The impact of depressed oil prices has undoubtedly been felt across the industry. Even as oil markets begin to move back toward something resembling normal and prices start climbing back to pre-2020 levels, recovery will be uneven and there will be volatility.

Nevertheless, with lockdowns lifting, factories reopening, and economic activity resuming in the Asia Pacific region, Australian producers are seeing demand bounce back to almost pre-pandemic levels.

“This recovery has been led largely by China, where manufacturing, construction, and transportation are resuming at a rapid pace,” says Charlotte Watts, Associate Director, Energy & Mining, Aon Asia. “Likewise, through a combination of strict quarantine measures, early adoption of travel restrictions, mass testing and contact tracing, we have seen other countries in Asia such as Taiwan, Singapore and Vietnam limiting cases and being able to return to normal much quicker.”

“As these countries and others in the region are opening back up, we are seeing an uptick in demand, supporting the region on its road to recovery during this time,” Watts adds. “However, the road to recovery is likely to be bumpy as we see countries going back into various states of lockdown as second and even third waves of the virus hit.”

“Indeed, we initially saw restrictions being lifted in India back in April 2020 which led to demand for motor fuel increasing,” she explains. “However, this was short-lived after a surge in cases led to stricter and more prolonged restrictions.”

The pandemic has also accelerated discussion around the adoption of decarbonization, renewable energy and green investment, amongst others, to meet future energy demand. For instance, Singapore has recently signaled its intentional shift towards green recovery and growth by announcing the Singapore Green Plan 2030, a “whole-of-nation movement” to advance the national agenda on sustainable development.

“Resilient businesses understand that operating environments are dynamic and changing,” says Greg Lowe, global head of sustainability and resilience at Aon. “Adapting accordingly is critical to coming out of this in a stronger position than before.”

Emerging risks on the road to recovery

As the oil markets begin moving towards recovery, oil producers are looking to expand their storage capacity and establish safety margins. There are many considerations to take into account, including the cost of leasing storage space, as well as transportation if the facilities are located at a distance from production sites. Adding to the supply chain will naturally expose new risks for producers.

“During the crisis, companies in Asia have been paying on average an extra 40 percent in inflated storage costs to store their product at third-party locations due to excessive demand,” Watts explains. “They have found that solutions like holistic insurance can help them address these unplanned changes in storage needs and new risks exposed along the supply chain.”

Balancing operational setbacks against risk

With budgets tightening among cash-strapped producers, some companies may be looking to delay upgrade and maintenance projects. “While this may be a viable short-term solution, deferring crucial maintenance work could also cause an increase in a company’s risk profile,” says Watts. This could have negative effects as operational energy insurers consider the insurance terms and capacity they’ll offer.

“What energy companies will need to ensure is that they have a considered approach that balances their risk profile against upcoming operational needs during this challenging time,” Watts added. “Otherwise, they could be looking at even higher costs, be it in insurance premium or in potential increased loss or damage if risks aren’t properly managed.”

The global oil industry will continue to see a tumultuous year. However, as demand inevitably picks up and the market edges towards recovery, oil producers may just find the perfect opportunity to review their risk profile as they chart a new course in the post-COVID-19 era.