Texan oil that collapses and sinks in a few months from 64 to -37,6 dollars/barrel, on Monday 20 April, on May deliveries. The slight rise to 16 dollars on June contracts, immediately after. Science fiction scenes, never seen before, have shocked the markets already grappling with the very heavy post-coronavirus crisis. However, the extreme volatility allows us to glimpse new scenarios, including geopolitical ones, and structural changes for a strategic sector such as that of energy.
So anything can happen? “The oil price shock we are witnessing once again shows the underlying vulnerability of an oil-centric system. And history teaches that with the repetition of these signals, capitalism renews itself, even through dramatic social suffering. In my opinion, the collapse and volatility of crude oil prices strengthen the path towards the great energy transformation, which has already been underway for some decades; they increase the pressure towards a model based on renewable sources, gas and tools made available by the digital revolution that offer new services connected to electricity platforms.”
Valeria Termini, full professor of Political Economy at Roma Tre University and member - between 2011 and 2018 - of the Energy Authority, is convinced of this, after having represented the country in international negotiations for Climate Change, positions that have allowed us to look at the energy sector from different points of view. Your analysis is interesting and in some respects opposed to that of other economists, which leaves room for an irreversible development of renewable sources combined with gas and the advance of the digitization of networks and new connected services. Let's take a closer look at it in this interview with FIRSTonline.
Will the collapse in oil prices have structural effects on the sector? And how long will it last?
“The price earthquake we are witnessing is certainly a strong shock for the system which adds to the extraordinary economic crisis caused by the pandemic. And it is a fact that goes beyond the sector and the simple economic situation. To understand its significance, I think we must distinguish between short-term factors and longer-term, structural reasons. Among the former is the financial element determined by the expiry of May futures last Tuesday, the scarce availability of storage in the face of the overproduction of oil to be placed, the eruption of speculation on the markets. The price of futures in June has recovered, also because the production cuts announced for May will become operational and the availability of the Strategic Reserves of the Governments of the United States, China, Korea and other countries will expand to accommodate the oil surplus. The shock on fears of depletion of stocks seems more linked to the surprise effect than to actual saturation. But the structural problem of excess production and collapsing demand persists.”
In short, there was a short circuit fed by the tensions and by the strong volatility of the markets….
“We are facing a doubly extraordinary situation, it is a fact. But it is useful to ask how and why this shock came about. The current situation comes from afar: from the attempt to oust the American companies that produce unconventional oil (shale oil) with an extraordinary growth rate and absorb increasing shares of global demand. The ongoing clash in Opec Plus between Saudi Arabia and Russia was grafted onto this: the tug of war over the production cuts requested on March 6 by the Saudi Kingdom to support the price in the face of the sharp drop in world demand; Putin's refusal and indeed the strategy to further expand output; the Saudi countermove to relaunch with new production and price discounts to defend its market share. All this triggered an unsustainable collapse in prices which Donald Trump belatedly tried to remedy close to the expiry of the contracts, resurrecting the OPEC plus Agreement on April 10th on cuts of 9,7 million barrels/day starting from May . A descent into the field aimed at protecting American producers of shale oil which today guarantee about 70% of the 12 million barrels/day produced by the United States. But it was an insufficient agreement to reassure the market which has been putting pressure on the companies for some time majors. And in fact she did not appreciate it ”.
In the background is the attempt to cut off the producers of tight oil from the market, a second attempt after the one in 2014 that failed?
“Yes, but the conditions today are profoundly different. Then, the break even (the price that covers the costs) of those companies dropped from 80 to 45 dollars in a short time and US producers showed unexpected resilience, remaining competitive even with the new prices. Although the attempt to expel them failed at the time, many companies went out of business. This time it can succeed. For three fundamental reasons, both financial and real in nature”.
Which?
“The first is the extraordinary imbalance on quantities. Demand for oil initially fell due to lower demand from China, today the demand abyss has widened to 30 million barrels/day. The 30% drop in demand was offset by an increase in supply mainly due to the producers of shale Americans. The US became a net exporter of crude oil for the first time, a political triumph for the country.
The second consideration, as we said, concerns the delivery of the May contracts with the storage sites unprepared to welcome the arrival of new oil. The American market was particularly affected by this and in fact it was the Wti reference price that fell more than the European Brent.
The third factor is financial: speculation runs where it sees the fire and here the fire was high, both of a financial and real nature. Therefore, to answer your question about how long the current price shock can last: much will depend on the resilience of American oil companies, further production cuts, and of course the recovery of activity in the world after the pandemic, especially in China, the largest oil importer.
If you had to make a prediction?
“This time it will be much more difficult for American companies to resist, so much so that President Trump has already asked for financial support for the sector shale and an easing of the CO2 reduction constraints: two interventions that are certainly not positive for the global scenario. Giants like Chevron and Exxon mobil have managed to bring their own break even under 30 dollars but they pay very high costs to the market in terms of capitalization and investment capacity. Others, like Occidental Petroleum, have seen shares drop from $40 to $14 in just a few months, amid $40 billion in debt. There are perhaps a dozen, out of several hundred, American companies that can afford a price of less than $40; the others risk losing control of the company in favor of banks and lenders, because the debt is very high and in the face of a low operating margin and a collapse in capitalisation, companies will have difficulty refinancing maturing debts”.
In practice, at current prices – well below $30 – many US producers risk going bankrupt. Good news for Putin's Russia.
"Yes, but only partially. Indeed, it is true that the break even the Russian price is 15 dollars to cover the costs and the Saudi one is even lower, but it is equally true that economic and social stability both in Russia and in Saudi Arabia require a much higher price: we are around 80 dollars. They too will have to deal with the collapse in prices which is putting all the producing countries in difficulty”.
Summing up, therefore, who wins and who loses in the "war" of oil?
“The first battle sees Putin ahead, but for how long? Gas, on which Putin is aiming, has strengthened, is more stable; the attack on the companies of the shale seems to be successful. I would say that Putin was able to open the conflict in Opec Plus thanks to the agreement with China on the gas pipeline Power of Siberia, the new infrastructure ($400 billion) that brings gas from Siberia to North-Eastern China. An agreement that strengthens the alliance between Putin and Xi Jin Ping in an anti-Trump version. In the long run, however, Russia may not win this war. In my opinion, the "winner" will be energy transformation: the vulnerability expressed by oil, together with the perceived climate risk, push towards a new economy model that will give more space to renewable sources, digital and gas as a stabilizer. However, the lower oil price is not competitive with the new model. A historic opportunity opens up both for Europe and for Italy, well positioned in these sectors; new services connected to renewable sources, which today may seem niche, will become central to the new energy model. It is a question of building a systemic and long-term industrial strategy in the country”.
Is there immediate hope that the current earthquake will lead to a drop in the price of fuel and electricity bills?
"The drop in prices is certainly positive for those who import oil but it will be transferred to a minimal extent on fuels, considering that over half of the final price is absorbed by excise duties – some of which are frankly folkloric such as the residue from the Abyssinian war or the Suez crisis - in addition to VAT. For the electricity bill there is a small possibility of transferring to the extra tariffs but also in this case the raw material accounts for 30% of the price since, in addition to the taxes, the greater weight here is of the incentives, of the system charges”.
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