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2020 was a tumultuous year for oil markets, and energy markets
more generally. The COVID-19 pandemic decimated global oil demand,
which plummeted in the second quarter at an astonishing rate as
lockdowns and other pandemic-related restrictions came into force
and whole countries abruptly stopped driving and flying. Oil prices
tumbled, and a brief price war between Saudi Arabia and Russia
deepened the rout until an historic agreement was struck between
OPEC and several non-OPEC producers to slash output by the greatest
volume in history—nearly 10 MMb/d. Other producers outside the
agreement joined the cuts, albeit involuntarily—with customers
disappearing, and in some cases with nowhere to store the excess
output, their only choice was to shut in wells. This great shut-in
of production and some recovery in oil demand in the second half of
the year helped prices partially recover.
What comes next? The precise contours of the post COVID-19 era
for oil and energy markets have yet to emerge. But we can already
anticipate what some of the key themes will be for this
year—and potentially beyond.
Oil demand and the energy transition
For the oil market, the biggest uncertainty is the future path
of demand. Yes, vaccines are now being rolled out, and world oil
demand will almost certainly jump later this year as the pandemic
is contained, economic activity increases and travel rebounds. But
there are reasons to believe that a return to the roughly 1%
average annual increases in world oil demand that have occurred
over the past three decades may not resume. In the IHS Markit
Autonomy energy scenario—which depicts a faster transition to a
lower-carbon economy than in our base case Rivalry—2019 is the
highwater mark for world oil demand, owing to the emergence of new
consumer behavioral trends and government policies that limit oil
consumption. An early peak in world oil demand would have profound
implications for energy industry strategy, investment and oil
prices. Upstream oil companies will be considering investment
decisions with this potential peak in mind.
2020 was also the year when the energy transition appears to
have reached a pivot point. From 1990 to 2019, decarbonization has
been moving in slow motion, with fossil fuels maintaining about an
80% market share of world primary energy consumption. But the
pandemic reduced fossil fuel usage by a record amount.
There was also a marked shift in investment away from oil and
gas and to renewables, driven by several trends. First, costs for
renewables like solar, wind and batteries continue to drop,
pointing to further gains in noncarbon energy's global market share
over the next decade. Second, environmental, social and corporate
governance (ESG) criteria are becoming increasingly important for
investors. The COVID pandemic has also prompted some big oil
companies, such as Shell and BP, to accelerate their energy
transition strategies, shifting investment away from traditional
oil and gas activities. Finally, governments around the world are
setting ambitious "net zero" targets for their economies. Can the
energy transition finally move beyond slow motion in 2021?
The oil supply challenge
Even if the future oil demand growth profile is flatter,
upstream investment is still needed—after all, existing
production is constantly in decline, requiring new sources of
supply to backfill it. In fact, it is plausible that insufficient
investment in the years ahead could eventually result in a much
tighter market and oil price spikes.
Global E&P capital spending fell 30% in 2020, with the
biggest drop in North America. Even with a recovery in oil prices
and revenue, the industry faces a unique set of challenges that
could constrain future investment. Oil company debt levels are at
record levels, and its investors are disenchanted with the sector.
Over the past decade, the energy was the worst-performing sector in
the S&P 500 index, and investors are clamoring for higher
returns. Oil companies, especially the US shale sector, are heeding
that demand, and capital discipline is the watchword for the
foreseeable future. An added headwind is that the cost to develop
new upstream projects is not expected to decline much.
The oil market's heavyweights in OPEC (and their non-OPEC
partners—especially Russia) also face a supply
challenge—how to calibrate the return of their barrels to the
market as demand recovers from the pandemic. This effort will be
fraught, since the group is internally divided over its strategy.
For example, Russia favors increasing supply at $50/bbl, unwilling
to forgo market share. Saudi Arabia, however, prefers higher
prices. Meanwhile, higher output from Iraq and potentially from
Iran could further test the unity of the group.
The Biden Administration's policy ambitions will leave a
mark on the energy and automotive industries
The change in US government leadership will also have important
repercussions for the oil and gas industry. For example, the Biden
Administration has proposed a ban on new permits for oil and gas
drilling on Federal lands and waters. Most drilling is on private
land, but if the ban is implemented, it could still eventually
suppress the long-term potential output of US oil production. On 20
January—Biden's first day in office—he revoked the
cross-border permit for the Keystone XL pipeline, and work on the
project has since been suspended.
Relationships with key allies and geopolitical adversaries could
also shift with a new US administration. Perhaps most importantly
for the oil market, the Biden Administration is seeking to revive
the Iranian nuclear agreement (the "Joint Comprehensive Plan of
Action"). If Trump-era US sanctions on Iran are eventually lifted,
the country's oil production and exports could rise very rapidly,
challenging the efforts of OPEC+ to manage global supply. Evolving
US relations with China, Russia, and Saudi Arabia could also buffer
oil markets in unpredictable ways.
The Biden Administration is also supporting policies aimed at
reducing GHG emissions from the transportation sector, which
remains heavily reliant on petroleum, and is the primary source of
oil demand in the United States. President Biden will likely move
to accelerate increases in US fuel economy standards for passenger
cars and light trucks and promote electric vehicles (EVs). Pro-EV
policies pursued by Biden may include supporting the construction
of more charging stations, a push to buy "clean" vehicles for
public sector fleets, and more generous consumer EV purchase
incentives.
More broadly, in 2021 and beyond, the transportation sector is
likely to come into greater focus among policymakers around the
world seeking to put their economies on a path to net-zero
emissions. In 2020, the United Kingdom, California, Massachusetts,
and Quebec separately set 100% zero emission vehicle (ZEV) new
sales goals in the 2030-35 period. More such targets are likely in
the offing. However, governments will also need to put in place
tougher regulations—including tighter fuel economy/GHG
emissions standards—that constitute the "blocking and tackling"
needed to realize such ambitions.
While ZEVs will continue to be a policy-driven market for years
to come, there are other factors that will help determine the pace
of ZEV adoption as well—including a narrowing difference in the
price of battery electric vehicles and internal combustion engine
vehicles; increased availability of EV chargers outside the home;
and the availability of many more ZEV models, including sport
utility vehicles.
