Covid-19 and climate worries may not keep oil prices down for long
- China’s economy is firing up, supporting demand for industrial metals and oil. Once the rest of the world follows China into economic recovery, high demand and short supply might mean higher oil prices
With coronavirus still raging, the market cannot fully price in the prospect of a post-pandemic vaccine-driven global economic recovery. Yet, if China is any indicator, there may be grounds for optimism. Beijing has got to grips with the coronavirus even as other major economies are trying to contain the pandemic within their borders.
Recovery from Covid-19 may see other major economies spring back to life pretty quickly, supported by ultra-accommodative monetary policies, and driven by large-scale infrastructure projects and resurgent consumer demand. And all this post-pandemic economic activity will require greater use of energy.
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Markets might also conclude that pursuing post-pandemic economic recovery might lead policymakers in many major economies to be more focused on job re-creation than any signs of rising inflation.
If so, and especially if there is accompanying broad greenback weakness in the currency markets, commodities that are often regarded as good hedges against inflation, such as gold and oil, might attract investor interest.
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Supply issues also need to be considered. The Paris-based International Energy Agency (IEA) recently wrote that the pandemic has “exacerbated many of the longer-term challenges facing fuel suppliers”.
US shale oil, or tight oil, is a case in point. The costs of extracting shale oil significantly exceed those that major Middle East oil producers have to contend with. In consequence, to be competitive, US tight oil has essentially required a relatively high crude price combined with ready access to cheap finance.
With coronavirus having weighed on the demand for oil this year, the business model of US shale oil and gas producers has been pressured. The oil price fell and big lenders to US shale oil companies have incurred some substantial write-offs on their exposure to the sector. Those lenders are likely to think twice before dispensing new shale energy loans.
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Given that, as the IEA attested, US shale oil has been “the main engine of supply growth in recent years”, if that sector cannot meaningfully respond to a post-pandemic increase in oil demand, then that should underpin the price of crude.
Swing producers such as Opec will respond, but in line with their own interests and mindful that, globally, policymakers are increasingly pushing a drive towards renewable energy as part of wider efforts to combat climate change. The oil-producers’ cartel will seek to achieve balance in the global oil market but at a price that suits it.
But getting there will require massive investment and reliance on oil and gas. After all, China’s Three Gorges dam might be generating clean hydroelectric power now but its construction depended on traditional energy sources.
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Yet, the climate change agenda is already forcing major oil companies to recalibrate their operations while investors might become increasingly reluctant to finance oil and gas projects, given the global push towards renewable energy. Oil supply constraints may emerge, even as demand for crude increases.
It might be a mistake to assume that the current combination of coronavirus, impaired worldwide economic growth and the global climate change agenda is bad news for the oil price in the next few years. The price of crude may be on the rise. It’s a matter of demand and supply.
Neal Kimberley is a commentator on macroeconomics and financial markets
