COVID-19 and the Post-Pandemic Economy: Impacts on Oil, Gas, LNG and Power Markets and Climate Policy

In the conclusion of a three-part series, Christopher Goncalves and Robert Stoddard talk with host Michael Whalen about how COVID-19 has played an important role in the recent record-low oil prices and the pandemic’s effect on oil and natural gas. They also provide an idea on how this could lead to a new emphasis on green energy.

Listen to the first two episodes:

• Implications and Economic Recovery
• Implications for Energy Financing and Capital Access

TRANSCRIPT

00:02     [music] Welcome to BRG ThinkSet podcast. I’m your host, Michael Whalen, an expert in BRG’s Energy and Climate practice. BRG is a global consulting firm. We help organizations in disputes and investigations, corporate finance, and performance improvement and advisory. We’re a multi-disciplined group of experts, industry leaders, academics, data scientists, and professionals. Around the world, BRG delivers the inspired insights and practical strategies our clients need to stay ahead of what’s next. For more information about BRG, please, visit thinkbrg.com.

In this, part three of a special three-part series, we’ll discuss COVID-19’s role in the recent record low oil prices, the pandemic’s effects on oil and natural gas, and an optimistic view on how this moment might lead to a new emphasis on green energy. Joining us from Washington, DC, is Chris Goncalves, chair and managing director of BRG’s Energy and Climate practice. Also joining us from Portland, Maine, is Robert Stoddard, a managing director in the energy and climate practice who leads responsibilities for BRG’s work and power and renewables. And with that, let’s get started.

MW 01:20            Chris, the effects of COVID-19 have been brutal for the energy sector on the producing side; you have Saudi Arabia and Russia triggering a supply war. On the demand side, the economic standstill has crushed consumption and we’ve seen obviously some pretty traumatic prices recently. But let’s address demand first. How bad is it and when do you expect it’s going to come back.

CG 01:43               It’s an excellent question, Michael, and we hope all of our audience is keeping safe and doing well. As far as demand goes, the initial estimates for early April have been on the order of thirty percent of demand or just around thirty million barrels per day off the market. But I think these are initial informal estimates and, of course, things are changing constantly right now. We know that air travel is virtually shut down. Maritime shipping is very limited. Ground transport is down to a fraction of its former self in terms of commuting and trucking and so forth. So we’ve got a very substantial downturn. And I’ve heard numbers that we could get as far down as on balance across the whole sort of oil and petroleum product market as much as forty to fifty percent. I don’t think we’ve gotten there yet and hopefully things turn around in the near future. But it has been very, very substantial.

MW 02:43            And do you think it’s going to be coming back or is this going to be a permanent impairment in consumption patterns?

CG 02:48               I think it will come back, but I don’t believe that it will come back in full. There are several reasons for that. First, we are already in a recession and expect to be in a pretty deep recession. There’s even talk of a depression. Whatever the case may be, there’s something very substantial, economically, that is happening now and going to result from all the shutdowns and the loss of jobs and livelihoods and so forth. So that, inevitably, results in reduced demand and that will last as long as it lasts but it will last more than a couple of months. It would last a quarter or two quarters, maybe longer. Then there’s the issue of structural adjustments in sort of work and travel patterns. While one would expect with a pretty healthy or robust economic rebound that commuting would pick back up to similar levels. We’re not so sure about maritime shipping. I mean, that would also track economic activity, but we have been in several trade wars for the last couple of years as well as now the effects of COVID-19 and all the shutdowns. With economies in trouble around the world, whether trade resumes to its full level remains to be seen. But I think we can be skeptical that it will get back to where it was just late last year or early this year. And finally, perhaps the most pronounced sustained impact is at risk of occurring in the airline sector and air travel because of all the uncertainties around testing and recovery and whether or not we will have a vaccine and then the roll out of that vaccine, with discussion of that really not taking place or reaching any kind of scale until 2021. If we’re fortunate, one can expect that air travel’s going to remain reduced substantially for quite a long time.

MW 04:33            So, Chris, we’ve seen extraordinary prices for crude oil in the spot and futures market, which seem to be linked to global storage capacity either being at or close to full capacity and there have been some actions by the so-called OPEC plus supply cuts to try and stem the drop in crude oil prices. Is this going to help or is other action likely or going to be required to address the low price market?

CG 05:00               Another very good question and a challenging one. The actions so far include the OPEC Plus agreement to reduce oil production by 9.7 million barrels per day during the month of May. It doesn’t take effect until May. Right now what’s actually happening and part of the reason for the negative oil prices, recently, is that Saudi Arabia has been producing a tremendous amount of oil and selling it at a deep discount into the Asian markets. We then have the situation where Chinese buyers, for example, that had hydrocarbon purchase obligations under the trade deal with the Trump administration are not fulfilling those requirements. US exporters, of course, are not able to sell as much as they wanted and the production is getting bottled up inside North America. The US commercial storage for the month of May is booked out. It’s not physically full right now, but it’s very close. It’s reportedly within two weeks or so of being full physically and it’s booked out for the month of May. So really when you look at the futures contract for May, the reason for the negative numbers has been that there’s really nowhere for the US production to go. Internationally it’s a little different, we do have 1.5 billion barrels of storage capacity internationally and there is some room for additional injections into storage, but that is also reaching capacity. I think I’ve seen reports that it could reach capacity by the month of June if we keep loading crude into storage at the rates we’ve been doing recently. And, of course, storage is really only a temporary solution. It’s a stopgap measure to take account of surplus barrels in the short term over the coming months. But that’s not going to be adequate to address the longer-term demand impacts we discussed. And what we’ve seen is with a 9.7 billion barrel reduction from OPEC Plus which, of course, then scales down to even less. I think it’s six or seven million barrels in the summer months and then it phases out altogether. This is really not adequate to deal with the amount of demand destruction that’s occurring in the market and the result is going to be extreme price pressure until—and this is to address the second part of your question—there’s some other action taken, and I’d say that action could either be another political agreement to reduce production by the leading producers very substantially; it would have to be quite a bit more than the OPEC Plus agreement. It does seem quite unlikely. I’ve heard estimates that to achieve say a twenty or thirty-million barrel reduction would require Russia and Saudi to stop producing oil altogether, which is not something that’s realistic. The other kind of action would just be market response of producers shutting in production; shutting down wells; and taking production off line because prices are not adequate to produce and they can’t liquidate the barrels; they can’t find buyers. And some of both of those are likely to happen but it remains to be seen how much political will there is for additional cuts and how much commercial pain the producers will have to take to sort of balance the market.

MW 07:56            Chris, it’s been since the 1980s when I was a high schooler in Houston that I’ve heard so much talk about the Texas Railroad Commission. But that’s one aspect, which is interesting in relation to that—segueing to the other element of US energy outlook—has been the shale gas boom, which really relied on a substantial amount of natural gas production that was associated, meaning it kind of came along with the ride for when companies were extracting oil and natural gas liquids. So what are the pain points for US natural gas production if crude and liquid prices remain stressed as they are now?

CG 08:31               Yeah, what we expect to happen in our forecasts is that from all of the things we’ve just discussed, inevitably associated gas production will decline because oil production declines and natural gas liquids rich shale production. We’re talking about big liquids rich production in places like the Permian, the Eagle Ford, and the Marcellus place, which are some of the most prolific plays in North America will also suffer some of this pain because the liquids revenue that the producers have been chasing; we’re talking about ethane, propane, butane, and so forth. Those prices are largely correlated to oil and so declining also with oil and those liquids revenues have been really subsidizing a lot of the production of dry gas or methane just like the oil production revenue has been subsidizing the production of associated gas in the oil place like the Permian and the Bakken. So as the production inevitably declines due to the oil price problems and as the liquids revenue inevitably is reduced by lower oil prices and liquids prices, it’s going to remove a lot of that incentive. And there’s a lot of drilled and uncompleted wells out there that can be produced in the near-term economically because they’re partially complete and that will buy some time, perhaps, to get over the next three to six months. But there’s going to be pretty quickly a transition toward more dry gas production, either within those plays that I’ve mentioned where there are dry gas areas, which is just unassociated gas that’s not dependent on oil production or liquids production and in some of the plays that are known to be primarily dry like the Haynesville play, for example. That production in the absence of those subsidies from oil prices and liquids prices will be more expensive, more costly and as that shift occurs, we expect prices to rise. You already see this in natural gas futures market that there’s been some firming up of gas prices. We were down in the low ‘150s not too long ago and now getting up toward $2 and we do expect to see prices more in the 2 to 3 dollar range, particularly, around the mid ‘2s as this shift plays out and become more apparent. I should also condition that though to say if there is a big supply disruption, in other words, if this isn’t an orderly process and something more dramatic happens faster than expected, you could see price spikes and price volatility. If it goes more orderly, then we would expect just sort of a more gradual escalation from the mid 1s to the mid 2s over time. So these are still historically pretty low gas prices. I mean overall it looks like the gas industry will do okay. Prices will be within a reasonable range and nothing that would be terribly shocking to gas consumers. The other point to make, of course, is that there’s just an abundant, very ample amount of natural gas out there. So shifting to dry gas is not problematic because there’s plenty of it. And that’s really where the shale revolution started is with dry gas production and the liquids rich came after. So it’s really just kind of going back to the basics of dry shale gas production.

MW 11:38            So then let’s shift to the other conventional hydrocarbon market, which had been a bright spot before the COVID-19 crisis, and that’s the liquefied natural gas market, LNG, which the US has become a substantial exporter for and we have a number of trains coming online. How does this market situation reverberate through the LNG market?

CG 12:00               Of course, one of the biggest drivers. I think the single biggest driver of the LNG industry for the last several years has been the abundant shale gas production and its declining cost and price, which has made the US LNG exports very competitive and attractive around the world. I think we’re now up to providing feed gas to LNG terminals or we’re recently up to almost 10 DCA per day, which is a remarkable accomplishment at more than ten percent of the US market or of US production being accounted for by LNG exports. Looking forward from here, rising prices for natural gas will undermine those economics. It remains to be seen how much that will be the case because it’s also true that US LNG exports have come to effectively set the price for LNG up until most recently. The declining price of LNG around the world has largely been due to the ample supply of US LNG. Its flexibility, the liquidity and depth in the market, and essentially the cost of US LNG plus shipping and transportation—it was sort of beginning to set LNG prices. We’re now to a point where there is so much oversupply and, of course, demand disruption due to COVID-19 that foreign prices are even lower than that where you now have Asian prices, European prices on par with Henry Hub in the US. So we really have kind of global alignment of pricing that. What that means in the short term is you can’t make money exporting US LNG. There’s no margin there to pay for liquefaction and shipping, at least not in full and even not on a variable cost basis. So that’s, obviously, a problem in the short term. Looking out ahead though, it looks to be the case for both the power sector and the gas sector, internationally, that unlike oil demand, is really only off say ten to fifteen percent and we’re already seeing, for example, in China, which is one of the first countries to start to rebound from COVID-19, that demand for gas and LNG are picking right back up as well as power. And so it looks like gas demand, broadly speaking, will do okay and will bounce back better and faster than demand for oil. If that’s the case, then it should be also the case that prices firm up again internationally and begin to reflect a more logical sort of cost of supply, US LNG supply being represented by an FOB price in the United States plus delivery to foreign markets where you have at least enough differential between foreign prices and Henry Hub to pay for most or all of liquefaction and shipping. Again, a lot depends on the speed of recovery and the amount of demand. We’re also seeing, right now, some disruption of the supply projects, meaning some of those projects that were expected to take final investment decision or FID in 2020 are now looking like they may have to be delayed until 2021 or 2022 and that would push the corresponding LNG supply that they produce down the road from commercial operation in say 2024, 2025 until the late 2020s. So this delay effect will also reverberate through the market and cause, at least, a temporary supply reduction. I think the two things could actually bode reasonably well for a healthy kind of LNG industry, which means rebounding production in the next year or two. And a delay of new supply should have the effect of re-balancing and creating a more orderly resumption of healthy LNG trade.

MW 15:29            Well, let’s turn to renewable energy. And Robert, if it was difficult to compete with low natural gas prices and hydrocarbon fuels, I can only imagine that negative prices are a potential barrier to renewables growth in interest in low carbon alternatives. Is that correct or do you have a different view?

RS 15:47               I have a different view on that one, Michael. The market for renewables I think continues to look very strong now. Now, there clearly have been some impacts in the short run out of this crisis and we’re looking at some things like supply-chain disruption. I mean, if we’re actively going out and building a new solar farm, you need to have the panels; you need to have all the balance of system and a lot of those parts were stuck in China or stuck in warehouses that people can’t get to them. Some of the states have stopped construction during the shelter-in-place order, which has hurt. And there’s been a certain amount of demand delay with, particularly, households where there is concern about having people in and around the house or just concerned about cash flow quite reasonably. People want to stay liquid and are concerned about undertaking a big capital project today. So, particularly, in the solar rooftop installers there has been some issues in the market currently. But if you look down on a longer-term basis, I just don’t see that we’ve got anything that’s seriously affecting the trajectory we had been on before. Renewables have been gaining ground rapidly. They are by far the largest segment of the market growth. And there’s good reason for that. In areas where you have good renewable resources, good wind, good solar, the localized cost of energy it has been below natural gas for a while. And even if you model that out at a dollar fifty gas, which we don’t see as a sustainable price but is where it is about today, those lifetime costs of energy still stay low for renewables, making them very cost competitive.

RS 17:16               We’ve seen a number of RFPs by utilities where the renewable option was chosen as the lowest cost bidder. That’s not going to change and the long-term view is about a long-term cost of natural gas, which is not being driven by the current disruption to the market. I think another important thing to keep in mind with the demand for renewable energy, a lot of that is driven by government policy or by corporate policies. Governments have mandates for renewable power. Big companies like Google have adopted aggressive policies towards one hundred percent renewable. They are going out and building their own wind farms and their own solar farms and that’s not changing again except for the supply disruptions we just talked about earlier. So I see a great push forward on renewable energy that’s only being slightly reduced if there’s a way even to think about the low gas cost currently as an opportunity for renewable energy. Renewable energy, in order to be operable in the system, needs to have a firming resource—something to make up for the fact that when the wind is blowing sufficiently and at nighttime and we’ve got to make up a difference between the daytime and nighttime generation; you need something to fill that in. And that’s something today is, typically, natural gas. While we’d like to be shifting to energy storage the installed base of energy storage is nearly sufficient to do that work. So if you have to firm renewables, having really low gas prices makes the combined renewable plus gas look quite cheap relative to traditional baseload operations of coal or nuclear. So it’s coal and nuclear that I’d be really concerned about right now. Another point that is a silver lining for renewable energy and this is something that Peter Keller talked about in an earlier podcast in the series. The cost of money right now is very cheap for high-quality borrowers. Renewable energy is entirely a capital play. It requires vast sums of money upfront but once it’s built, has virtually no operating cost certainly relative to traditional fossil fuel power plants. So if you are a well-capitalized company, with high-quality power purchase agreements for your off take, which is typical of renewable energy these days, you’re in a good position. We’re seeing in fact a lot of financing coming out in the capital markets for high-quality power. Looking even further past the immediate crisis though, I still am very, very bullish about where renewable energy is taking us. In addition to the long-term policy push, which I don’t see people backing down from, there’s also the fact that these technologies are still on the learning curve. There are still cost reductions to be had—perhaps less in wind and solar, which are getting to be fairly mature technologies—but certainly in offshore wind and then most critically in energy storage. Energy storage is really the key technology for de-carbonizing and increasing the underlying demand for renewable energy technology. When we can get that put together, I think the renewable energy path forward still looks very, very strong.

MW 20:11            So Robert, we talked about in the fossil fuel markets, what’s happening with prices and the potential for longer-term demand destruction. What’s happening in the power markets? I mean, we used to have a fairly linear relationship between economic growth and increases in power consumption and that’s really tapered off in a lot of the developed economies. What’s your sense as to what this means in the longer term and what the markets are telling us right now in terms of consumption patterns?

RS 20:39               Well, let’s start with the last question first. Where are we today? In places where there’s significant shelter in place, we’re seeing a moderate demand reduction—five, ten percent. One system operator referred to what they’re seeing on the system looking like a snow day but seven days a week where demand is down particularly in the morning peak and there is a distinct shift in the pattern away from commercial industrial buildings to residential, which is unsurprising. There is a footnote there, though. This helps utilities, utility cash flow because residential power pricing is typically a little more generous than CNI pricing. So the impact on utility cash flows is not nearly equal to what the reduction in demand looks like. Looking on the far side of the shelter in place orders, and what we’ve already seen in Wuhan and elsewhere in China, is that once these restrictions are lifted, electric demand rebounds to pretty close to their pre-pandemic levels. Businesses open, lights are on, and even if the production isn’t as high, the baseload power use is still robust. So I don’t think we’re going to see this demand destruction, at least not to the degree that Chris talked about on the oil and gas side. But to the extent we’ve got some longer-term effects here, I think the place that’s getting squeezed is the coal industry. Now coal had already been in a world of hurt; the margins were down. The inflexible operation of most coal plants makes it a poor match for an increasingly renewable energy-based system. And we haven’t talked about it, but the price of coal has not changed significantly during this pandemic. So at the same time as gas prices are coming down, high quantities of renewables, which are all bid in zero or negative prices into the power markets, coal really looks expensive right now. Nuclear is in a similar bind but there’s actually very little merchant nuclear left. The major nuclear power plants that had been in the merchant market, they all shifted over to zero emission credits in key states. There will be more demand for those merchant nuclear plants to shift to some other state support to keep them from closing. But there’s not going to be the political will in most states to keep coal on a lifeline as there has been for nuclear.

MW 22:50            Let’s end with a little bit of a back and forth with the two of you, because from our experience in prior crises we’ve heard the expression about “not letting a good crisis go to waste” and that certainly was something that was repeated a few times during the global financial crisis. From your perspectives, are there opportunities for climate policy in the aftermath of this pandemic? Let’s start with you Robert. And then Chris’s views.

RS 23:13               So absolutely. I think the push coming out of this will continue to be focused on poising society to be more resilient. This time the crisis was really about the healthcare system. But energy systems and infrastructure are going to be increasingly challenged. My hope would be we have some wisdom growing that we need to pay attention to those, and to put some really serious and focused attention into improving resilience and decreasing the need for that resilience by proactively helping address climate change in an active way. Another point—and this I think Chris and I have been talking a lot about—is there is going to be a need for cash. Right now, the US is basically printing trillions of dollars of money. State governments are in an even tougher place because they don’t have the ability to just take endless amounts of debt out. Foreign governments are also forking out lots of money or will do so going forward. Where does that money come from? And this seems like a golden opportunity at a time when carbon-based fuels are incredibly cheap and there there’s a high need for government revenue to put in place a carbon-pricing mechanism, which can raise funds; accomplish a lot of goals for the short run in things like infrastructure development but also ultimately have real positive effects in moving the needle on climate change mitigation.

MW 24:34            So Chris, what do you think. Do you agree with Robert or do you think some would argue that green stimulus policies and climate policies are going to be expensive luxuries post-COVID-19?

CG 24:44               I do agree with Robert and I would make a couple additional observations. I don’t think that green policies will look on the rebound from COVID-19 like expensive luxuries. I think they’ll actually look more like imperatives for some of the reasons Robert mentioned and some other reasons I’ll mention here, which is—as we’ve already discussed, the crisis itself is partially at least going to clear the field of some of the older less efficient sources of energy supply. Robert mentioned the impacts on coal-fired generation, which were already struggling. I think this will only accelerate the phase-out of some of that infrastructure because it’s not economic or competitive and probably won’t be in the near future. Just the same, we’ve already identified some critical amount of oil production around the world is going to be destroyed or shut in and that will open new market space as well. So I think there’s going to be a need for new sources of high-efficiency resilient energy infrastructure and that will be a desirable solution once demand starts to pick up in the coming years. I agree with Robert’s point about the need for government revenue. In fact, it could be stimulative to the extent that carbon taxes or prices in the future stimulate a lot of new investment in energy infrastructure. It’s going to create jobs and create economic growth in a new area that could be just the thing that society wants coming out the back end of a crisis like this. I think we’ve all learned at our own personal and societal peril to sort of deny the teachings of science and what the professionals, who are expert in things like epidemiology tell us, if we look the other way or pretend it isn’t so or hope it isn’t so. And those kinds of decisions can be fatal. We’ve already seen that in several countries around the world and we’ve learned that hard lesson. I think climate change is a bit harder to digest because it’s a longer-term, multi-generational problem; it’s not as immediate as COVID-19. It’s not as immediately life threatening. And it’s harder to perceive. But nevertheless, the scientific consensus on this is quite strong and there’s plenty of evidence that around North America, Europe, and increasingly worldwide, popular opinion is broadly behind it. So I think when you do all the math and you put all these things together; you have a kind of emerging social consensus that we need to take increasingly urgent action on climate change. You have governments that need substantial new sources of revenue and we’ll find coming out of recession, taxing income and corporations in any extreme amount to be problematic. And these two things go together pretty well. And so I think there’s not so much an opportunity for climate change policy but even more actually a need or an imperative for these kinds of policies coming out the back end of this crisis. And I think that will only serve to accelerate what’s already going to happen because of the economic impacts of COVID-19 economic shutdowns, lock downs, destruction of some energy demand in the short-term, some sustained destruction of energy supply. I think these policies are only going to accelerate what’s already happening anyway. And in that regard, they won’t look like expensive luxuries, rather like something that’s helping the market along in the direction it was already going. There’s a more mundane lesson that can be learned from what we’re seeing today: that the price of fossil fuel is low but it’s highly variable and is subject to a lot of political forces. This bothers people, maybe less than the United States because we are an energy exporter at this point. But in my conversations with people in Europe, they are always reminded that they live under the thumb of Russia, the Gulf countries, and are highly dependent on their fuel sources. That’s an easily forgotten lesson. It’s been a while since we’ve had OPEC very clearly and blatantly turning knobs; that’s come home again. An advantage of shifting to renewable energy and taking climate action firmly into your own hands, is it disrupts that political dependence between European countries and their fossil fuel suppliers. That could continue to be a compelling reason for European countries to pursue the climate change agenda that’s been advancing for the last 5 to 10 years there.

MW 29:05            Well thank you very much. Chris Goncalves, Robert Stoddard, thank you very much for joining us on the Think set podcast.

CG 29:10               Thank you.

RS 29:10               Thanks Michael.

MW 29:15            [music] This ThinkSet podcast is brought to you by BRG. You can subscribe to the podcast and access other content from think set magazine by going to think set mag dot com. Don’t forget to write and review this show on iTunes as well. I’m Michael Whalen. Thanks for listening. The views and opinions expressed in this podcast are those of the participants and do not necessarily reflect the opinions position or policy of Berkeley Research Group or its other employees and affiliates.