COVID-19: Impact on the Energy Industry
A Webinar with McKinsey & Company’s Scott S. Nyquist and Luciano Di Fiori
Emilly Fan
For HUCEG’s third speaker webinar, McKinsey & Company’s Scott Nyquist and Luciano Di Fiori provided insights into COVID-19 and its market impacts under different scenarios before delving into the specific impacts on the energy markets and the implications across the value chain. As the world gradually transitions to an economy powered by clean energy, it is important to understand the current oil and gas landscape in order to make informed decisions. Below is a summary of their presentation:
The Imperatives of our Time
The two imperatives of our time are “timeboxing” the virus and lessening the economic shock. Safeguarding lives by suppressing the virus as fast as possible through expanding treatment and testing capacity, and finding treatments such as drugs and vaccines is the priority. The second imperative is safeguarding livelihoods by supporting people and businesses affected by lockdowns and preparing for a safe return to work when the virus abates. Preparing to scale the recovery away from a -8 to -13% trough is critical.
A Range of Scenarios of Economic Impact
A number of scenarios of the economic impact of the COVID-19 were presented, with virus spread and the effectiveness of public health responses being the two key variables. These fell under three broad categories:
Rapid and effective control of virus spread: strong public health response succeeds in controlling spread in each country within 2-3 months
Effective response, but virus recurrence (regional): public health response initially succeeds but measures are not sufficient to prevent viral recurrence so regional social distancing continues for several months
Broad failure of public health interventions: failure to control the spread of the virus for an extended period of time (or until vaccines are available)
These translate to scenarios of economic impact that range from:
Highly effective interventions: strong policy responses prevent structural damage, leading to growth rebounds and recovery to pre-crisis fundamentals
Partially effective interventions: policy responses that partially offset economic damage, avoiding a banking crisis but with muted recovery levels
Ineffective interventions: self-reinforcing recessionary dynamics kick in meaning widespread bankruptcies and credit defaults and a potential banking crisis
Global Liquids Demand
In an optimistic Virus Contained scenario, this would require 2 to 4 years to recover to 2019 levels, however total demand still would not reach pre-COVID projections. Liquids include crude, condensates, NGLs, and other liquids (biofuels, processing gains, CTLs, GTLs, MTBE).
In a less optimistic Muted Recovery scenario, there would be structural changes in the economy driven by lower GDP outlook delaying demand recovery to 2019 levels by 4 years.
We expect behavioral changes and activity reduction to last throughout the lockdown periods but no permanent changes to remain in the longer term
Post-OPEC+ Supply-Side Scenarios
After the historic April OPEC+ meeting, the agreed upon cuts could lead to two potential supply scenarios in the short term:
The first scenario is one of OPEC+ alignment where Saudi Arabia, Russia and other OPEC+ members implement the full coordinated cuts as agreed. The rest of the market balancing is driven by reduction in new drilling activity and shut-ins in existing fields
The second scenario is one of OPEC+ non-compliance where Saudi Arabia, UAE, Kuwait, and Russia comply with the cuts but widespread non-compliance in the rest of OPEC+ fails the deal. In July, OPEC+ goes back to Q1 production levels for the rest of 2020. Market balancing would be largely driven by extended shut-ins and reduction in capex/drilling activity
U.S. Commercial Crude Stocks
Oil demand has collapsed due to the drastic drop in transportation needs so the recent negative prices are a reflection of the contracts for delivery of barrels in May that are traded on so-called futures markets.
U.S. commercial crude stocks and Cushing, OK stocks have been growing rapidly each week and are close to historical maximum. Cushing, Oklahoma is the largest oil-storage tank farm in the world. It has ~73 million barrels of working capacity, about 13 percent of total U.S. storage.
Assuming some capacity expansions, U.S. inventories would fill in ~20 weeks and Cushing stocks would fill in 3-5 weeks, or the middle of May.
Global Gas Demand
Due to the pandemic, global gas demand is down by 5-10% in 2020 while the drop in LNG and piped gas trades are more muted
Gas demand is expected to fall by 5% in an optimistic Virus Contained scenario but a rapid economic recovery into 2021 would enable gas demand to catch up with the pre-COVID-19 projections by 2025. In the Muted Recovery scenario, gas demand would only return to pre-COVID levels by 2022
Power Demand
The expected impact to power demand is largely differentiated by the speed of recovery
Markets are already seeing demand losses with ISO New England & PJM reporting decline in system demand of approximately 3-5% compared to typical previous demand in the region during this period
MISO seeing peaks this month down 18% compared to March 2019
Implications for Upstream
In addition to safety and business continuity, preserving cash is the immediate priority. Increasingly, a question the industry will face is when to shut-in production, as oil supply outstrips capacity. Currently, all cash preservation levers are on the table and announcements are accelerating. However, it will take time to see the full implications of production. 2020 hedges will extend some activity levels, and the impact on deepwater production will lag.
In the mid-longer term, a considerable restructuring of the industry is likely and was already in the beginning stages even before COVID-19. Restructuring of the E&P (oil and gas exploration & production) landscape is inevitable. 2020-2024 will trigger bankruptcies in places like the U.S, however, prices at today’s level could accelerate the time frame. Distress in the services industry could destabilize the supply chain, creating counterparty risk and potential development of new operating/partnering models.
Implications for Downstream
Global oil products demand is expected to be 6.7-13.0 million bpd lower in 2020 than 2019, pushing refinery utilization and margins to historically low levels. Significant refining capacity will be operating below breakeven cash levels for a period of time, driving runs cuts and significant (temporary) plant closures, with all regions affected, especially Europe and Asia. Maximizing short-term cash flow from operations is a critical focus for refiners across the industry.
Implications for Gas and LNG Players
COVID-19 will intensify the LNG market oversupply in the near-term. Given the record-high of LNG project FIDs (final investment decisions), market structural rebalancing is pushed back to the late 2020s. There is North American gas demand contraction of 8-16%, driven by subdued demand in industrial and power demand
Implications for Power
At a macro level, the crisis will be difficult but manageable across the industry if early and strong actions are taken. It will be particularly acute over the next 3-4 months with highly variable impact by region, customer segment, and asset class. In the short term, coal and gas generation will be affected the most with gas disproportionately so. Under a recession scenario, we will likely see a meaningful shift in the generation assets. Lower prices and lower volumes would rapidly accelerate some economic retirements.
Commercial demand will likely reduce sharply, if not already, with the exception of healthcare, warehousing, and grocery/food sales. There may be a further drop from HVAC loads if building controls are adjusted. Residential loads will also spike and shift more towards the middle of the day. The near term implication on cash when coupled with non/delayed payment scenarios could be severe. Each utility will face a unique context regarding customer affordability and future pressure on rates as costs will need to be recovered under conditions of lower overall demand.
Renewable Energy
When it comes to new investments in renewable energy, investors may hold back due to having limited cash in their back pockets as well as the extreme uncertainties surrounding the pace of economic recovery. However, both this pandemic and the climate crisis highlight the importance of the fundamental shift from optimising for short term performance to long term resilience.
To read more about addressing climate change in a post-pandemic world, visit https://www.mckinsey.com/business-functions/sustainability/our-insights/addressing-climate-change-in-a-post-pandemic-world