Source: Bloomberg, by Liam Denning
If ever a year needed a shot of glass-half-full attitude, it’s 2020. I got it recently from an oil executive. Conversation turned inevitably to the pandemic and 10 million barrels a day of oil consumption — one in ten — going *poof*. Against which they offered this: Despite epic disruption, we still used 90 million barrels a day of the stuff. How’s that for describing the worst drop in oil demand ever?
They had reason to be cheerful, though. After spring’s sudden collapse, oil ends the year with renewed vigor. Brent crude is back above $50 a barrel, and energy stocks, which suffered the ignominy of shrinking into the smallest sector of the S&P 500, recently clawed their way back to being only the second smallest.
OPEC estimates demand averaged a hair under 90 million barrels a day this year, down 9.8 million a day from 2019. On the other hand, at an average price of $42 a barrel, that’s still $1.4 trillion of notional revenue just for the upstream bit of the industry. Not bad for a plague year.
This being a lockdown recession, gasoline and jet fuel bore the brunt. Which was the executive’s point: 10% of oil demand is basically flying to see your family and driving to the store more than necessary. But 90% is essential living that stops for nothing — driving you can’t avoid, truck deliveries, plastics and so forth. When Covid-19 is contained, the 10% stuff will come roaring back.
This 10/90 case — or 90/10, I guess — is actually a useful way of contemplating what comes next.
Think of the 10% as a short-term trade. Demand will undoubtedly jump next year. Not completely: OPEC forecasts only about 60% of what was lost in 2020 will come back in 2021. That’s still up 5.9 million barrels a day. With OPEC+ still holding barrels off the market and investment in new supply crushed, the stage is set for higher prices.
Meanwhile, continued monetary easing and (anticipated) fiscal stimulus stoke oil’s old friend, the revived inflation trade. This pushes money into raw materials — the Bloomberg Commodity Spot Index just hit a six-year high — and rotates some out of the froth of tech into the dregs of energy.
The recovery in oil demand is real but also a moving target in a market that usually yo-yos on much smaller swings. While crude futures have rallied, physical indicators such as refining margins remain low for this time of year. On crude supply, OPEC+ is under growing strain, which is hardly surprising: Four years on from its debut, the oil price is basically the same and members are producing way fewer barrels.
As for the inflation trade, besides the sheer denominator effect following 2020, we all know easy money must — just must — unleash the old bogeyman at some point. But I wonder if that point will be reached in the immediate aftermath of a pandemic, especially for an oil market where spare capacity runs to 8 million barrels a day.
The self-help thesis for oil companies is more robust, albeit one that’s on probation. All of which isn’t to say the 10% trade is doomed; rather that it could be a choppier affair than the past month’s surge.
In any case, it’s the 90 part of that 90/10 worldview that really matters; the buy-and-hold investment case rather than a short-term trade. It rests on an essential truth: Oil is deeply embedded in our society and daily behavior. Over the summer, I was surprised at how quickly the roads in my area went from eerily empty to something approaching pre-Covid normality. Sometimes, it just felt good to drive, destination less important than the sheer act of (socially distanced) movement.
One obvious rejoinder to that 90-million-barrel number is that it belies the actual damage Covid-19 inflicted. Back in April, when streets were emptying and hospital wards filling in cities around the world, demand plunged more than 20 million barrels a day.
How 2021’s stimulus dollars get spent (or not) is crucial not just to oil’s near-term trading prospects but the future of those 90 million barrels a day. Oil bulls may well hope for Republican victories in Georgia on January 5 to stymie the greener parts of President-elect Joe Biden’s agenda (although they should beware what Senate deadlock could mean for economic recovery).
More important than that is the context. We’re undergoing the second crisis in roughly a decade that has strengthened government’s role as an economic actor — with implications for how far climate policy will be defined by markets or mandates. The point here isn’t that the Green New Deal won’t be enacted; it’s that it got an airing at all — and pushed the debate in a more interventionist direction. On this front, the victory of relative centrist Biden could actually be helpful to the oil industry.