April 22, 2020
By Samuele Furfari.

Yes, the oil market starts to work, and too bad if traders lose money!

A Google translate from the French original, with permission of the author. https://www.contrepoints.org/2020/04/22/369770-mais-quel-choc-petrolier

Samuele Furfari

When electricity from wind or solar sources is regularly “sold” at a negative price because nature produces when the market does not want it, nobody takes offense. Yet this unnatural price comes from the pocket of all consumers. We accept – or rather we do not talk about it – because it is “green” and therefore no definition is good.

But it is enough that the oil is sold for a few minutes at a negative price for all the media, in particular social media, to go wild.

The future of the oil market
This technical epiphenomenon is hardly determining for the future of the oil market. As with any raw material, between production and consumption, there are more or less large volumes of storage. The economic collapse brought about by the Covid-19 led to an unexpected drop in demand for oil.

A similar phenomenon occurred on September 11, 2001 and during the Subprime crisis in 2008, but this time it is the whole world that is affected, longer and more deeply. So that oil stocks are saturated, tankers and supertankers still have some capacity, but storage prices have exploded. It is sometimes cheaper to sell at a loss than to pay for storage.

Yes, the oil market is starting to work, and too bad if the traders lose money!

The Covid-19 crisis revealed to the general public, and to certain journalists who had in mind that “the end of oil”, that the main energy market (35% in the EU) is working and is no longer under the control of OPEC countries or elsewhere of OPEC plus Russia (OPEC +).

Inventories are so large that it will take months, or even a year or two depending on the strength of the recovery, to bring them back to the normal level of a fluid market.

The return to normal
No one can predict when the recovery will return to consumption close to that before the crisis (close to 100 million barrels per day).

As a result, an abnormally low price of oil can be expected during the period of freeing up stocks and well beyond. Of course, as soon as the planes resume their normal course, the trucks will transport the raw materials or the finished products and that the automobile transport will resume, the demand will allow the oil companies to get out of the rut.

In countries which have had the experience of working from home during confinement, a modest fraction will continue it, mainly in the administrative field and certain services. But that will not be generalized: it is an illusion invented by who knows who that one is going to be able to make the world work from his home. Go tell it to traders, restaurateurs, tourist operators, construction workers and contractors, and teachers! It’s simply incongruous.

In any case, with a sluggish economy for too long and the pressure of the decreasing followers, the EU will never again be the engine of growth; the EU will passively watch the growth in demand that will take place outside and in spite of itself.

A worrying phenomenon?
The very people who support the oil industry are concerned about the damage that is going to be in this sector. But it is part of life in a market economy. There will be bankruptcies in the free world, but let’s not forget that 90% of the reserves belong to states.

The companies of the Middle East states have nothing to worry about: they will not go bankrupt. In the free world, there will be and it will lead to cheap repurchases by those who had the means to resist during this crisis.

A wave of consolidations at the end of the 1990s already took place, creating each time a group more powerful than the sum of the parts. Exxon bought 82 billion Mobil to partially reform Rockefeller’s Standard Oil. BP merged with Amoco. For the French and the Belgians let us recall the merger between Petrofina and Total which ended in an absorption, Total also rapidly absorbing Elf.

This natural phenomenon is nothing to worry about. On the contrary, it is economic efficiency (also energy efficiency!) Which creates essential synergies to pursue the technological innovations which are the real engine of business growth and which ultimately led to abandonment of the punitive geopolitics of certain oil-producing countries.

Of course, this will also happen in the field of source rock oil (shale oil) in the USA. But this is nothing new. I often like to recall that in December 2009 during the COP-15 which was held in Copenhagen, while the EU was trying to convince developing countries to follow it in order to reduce their CO2 emissions by 20% shimmer with 7.7 billion euros in aid, ExxonMobil bought the unknown XTO Energy for 41 billion dollars.

It was to capture the deposits that the small business owned when the majorn had not come to bring about the magnitude of the change – including geopolitics – that was going to create the mother rock oil. Other acquisitions, this time driven by necessity, will take place. So what ?

What will happen to the price of oil?
As it is essential and that it will remain so, its price will be determined above all by demand, because the reserves are amply sufficient and above all better diversified and distributed than during the oil shocks of the 1970s. This market is so huge that variations in Even low prices generate huge gains or losses, and so journalists will continue to tell us stories of ups and downs that in fact should only be of interest to traiders.

Fortunately, the title of yesterday’s Boursorama article “After the health crisis, preparing for the next oil shock” is actually a question. The article is good to talk about “impossible containment” of the fall in price.

The trend was already quite bearish before the Covid-19 crisis and he is therefore right to say that “no realistic reduction agreement could revive prices”. But from there to speak of shock seems excessive to me, the more so as “shock” remains in the collective imagination a shortage of oil. The reverse will happen.

As soon as the demand has to be satisfied, the pumps will restart in the existing wells and if necessary prospecting and completion of new wells will occur. The abundance of reserves, the war between Saudi Arabia and Russia which did not stem the fall and the inexistence of Iran and Venezuela sufficiently demonstrate that the geopolitics of the shortage does not exist more and therefore the price of oil will be “reasonable”.

The politically correct declarations of Shell or BP which announce that they will reach carbon neutrality in 30 years (it is still necessary to know if such announcements mean zero oil) are absolutely not likely to disrupt the huge, unavoidable market of oil, the Asian countries will take care of it.

Besides, what can the European Green Deal claim to add to replace oil by 2050? The obvious failure of biofuels policy in recent years has closed their doors to them, including for environmental reasons. So transport will become all electric?

It takes a lot of faith to believe it, especially since it is also claimed that heating, which represents 50% of the final energy demand in the EU, must become completely electric (let’s forget the fantasy of heating with wood if only for environmental reasons)? Of course all electric means for the EU all renewable!

Yes, there would be another solution: to continue confinement so as to stop transport definitively, which some of the Green Deal’s defendants do not hesitate to propose.

One industry that is currently losing, but one that will benefit when the situation returns to normal, is the petrochemical industry. The closure or reduction of refinery activity caused by the drop in transportation could cause a shortage in the petrochemical chain. The basic material for petrochemicals is generated during the refining of petroleum into petroleum products, but it is of course the demand for fuel for transport which determines production since petrochemicals represent only 13% of the demand for petroleum.

ICIS, a consultancy in the sector, estimates that of the 12.1 million barrels distilled daily in Europe, 6.6 million barrels are random with a reduction of 2.2 million barrels already effective. As a result, naphtha is becoming scarce and its price is increasing. CIHI estimates that 26% of the ethylene market in Europe is at risk. The price of the raw material could increase. But subsequently, when the price remains normal, the production price of petrochemicals, and therefore of plastic, will remain low.

I take this opportunity to make the reader aware of the importance of plastic. All the images of laboratories or hospitals that we are currently seeing are a demonstration that without plastic there would be none of this.

Rather than looking at the tree, it would be better to observe the forest in wonder. The revelation is not the low price of oil, but the paradigm shift we are experiencing. Oil – but also natural gas – are so abundant that it is urgent to change our key to reading the geopolitics of energy and its corollary, that is energy policy.

About the Author

Doctor of applied sciences and engineer, Samuele Furfari has been teaching energy geopolitics at the Free University of Brussels since 2003. He was a European civil servant for 36 years at the Directorate General for Energy of the European Commission. He is president of the European Society of Engineers and Industrialists.

Samuele Furfari’s books are on Amazon. https://www.amazon.fr/l/B004MOTXDA?_encoding=UTF8&redirectedFromKindleDbs=true&rfkd=1&shoppingPortalEnabled=true