A gas pump showing low fuel prices in Texas. Oil prices may not stay low for much longer. Photo: EPA-EFE
Neal Kimberley
Neal Kimberley

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
Covid-19 is still raging across the world, global economic activity remains impaired and there is a worldwide drive towards renewable energy as governments look to tackle climate change. That hardly seems a recipe for a higher oil price, but first impressions can be deceiving.
While the price of oil had tanked as markets recognised both the enormity of the pandemic and its knock-on effect on economic activity, crude oil prices have since bounced back amid growing optimism about the roll-out of effective vaccines to combat Covid-19.

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.

Data last week showed China’s manufacturing activity again looking healthy. Posting the sharpest advance since November 2010, the Caixin/Markit manufacturing purchasing managers’ index rose to 54.9 last month, eclipsing an already improved 53.6 reading in October.
The recent rise in the prices of industrial metals such as aluminium and copper reflect the effect of China’s post-pandemic economic renaissance. China’s economy is firing up, supporting demand for oil, and once the rest of the world follows China into economic recovery, it would hardly be surprising for the price of crude to behave like those of aluminium and copper.

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.


Coronavirus: How badly is Covid-19 disrupting the oil industry in the US and beyond?

Coronavirus: How badly is Covid-19 disrupting the oil industry in the US and beyond?

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.

As regards climate change, President-elect Joe Biden wants the United States to be a 100 per cent clean-energy economy by 2050, while President Xi Jinping has already pledged that China will be carbon-neutral by 2060.

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.


Glaciers in northwestern China melting at a ‘shocking’ rate and may disappear by 2050

Glaciers in northwestern China melting at a ‘shocking’ rate and may disappear by 2050

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

This article appeared in the South China Morning Post print edition as: Pandemic and climate worries may not keep oil down for long