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Trouble at the Pumps

by Fu Chengyu

July 15, 2020

The oil market shock has hit gas stations in China, including this Sinopec station.Fu Chengyu, Professor of Management and director of the Research Center on Governance and Management of Large Corporations at the Cheung Kong Graduate School of Business, recently shared his insights on the “Impact of the Oil Market Shock on the Global Economy.” His webinar attracted over 440,000 online viewers. Fu Chengyu has more than 40 years of experience in the oil and gas industry, including as chairman of Chinese oil and gas enterprise Sinopec and chairman and CEO of the China National Offshore Oil Corporation (CNOOC).  During the webinar, Professor Fu discussed the long term impact of the COVID-19 crisis on oil prices and how the dramatic fall in price has been a big plus for the Chinese economy.

“I believe four forces have led to the plummet in oil prices: changes in the capacity of the international industry; the relation between supply and demand on the international market; games between super powers and geopolitics, specifically the reasoning of Russia and Saudi Arabia in using oil for bargaining power; and the impact of COVID-19,” said Fu.

The glut of oil was the new norm even before the COVID-19 crisis, largely due to growing production of shale oil in the United States. This changed the game in the global industry by shifting the center of production to the US and disrupting oil geopolitics and supply-and-demand in the global industry.

“Oversupply became a new norm mainly due to the US’s growing production of shale oil. Reducing production in OPEC+ countries (a 24 member group consisting of the 14 OPEC nations and 10 non-OPEC nations) will not cause prices to rise when US shale oil is growing robustly. At the same time, the demand for oil has been weak since the financial crisis of 2008. The US’s dominance over incremental oil supply and energy geopolitics fueled the new round of price war in the oil industry.”

COVID-19 contributed to the falling prices by causing countries to lock their borders, which devastated international airlines and resulted in less demand for oil. Fu suggests that oil prices will not rise anytime soon, especially now that there is an oversupply of oil.

“From my observation and analysis, I predict that the price of West Texas Intermediate (WTI) crude may drop to below $20 per barrel and then rise to $20-23  and stay at that level for several months to half a year, although the specific timespan will depend on containment of COVID-19,” he said.

“After the pandemic is under control, the price may go to $25-30 per barrel as demand starts to grow when economies resume, although this scenario does not consider any new agreement made by OPEC+ to cut production. What we can see is that the WTI price will fluctuate between $25-20 per barrel for less than six months and may increase to $30-40 per barrel either when the COVID-19 pandemic is controlled, when 15-20 million barrels per day of production is cut by OPEC+ or shale oil production suffers a substantial reduction due to the collapse of shale oil companies in the US.

“When the global economy is fully recovered, the price might go to $50-60 per barrel, which is a sustainable price for the industry. An oil price higher than $60 per barrel may, on the contrary, restrain the development of the industry and stimulate the new energy and renewables industry.”  Professor Fu said low prices are good for oil importing countries as they help reduce economic costs, but added, “China is not able to buy more oil as it filled its oil storage capacity to more than 60% before prices plummeted. This supply will not be quickly consumed due to the lower levels of economic activity recorded during the Spring Festival and the COVID-19 pandemic. As China’s economy gradually recovers, it can consume reserves, buy oil futures and rent more tankers to store the oil.”   The average full domestic cost of oil production in China is above $50 per barrel. In Fu’s view, China should produce less during this time and buy more oil futures at the price of $30-40 to bring the average cost down while continuing to produce, so as to keep mines running.  Fu also shared his thoughts on the impact that lower prices will have on private businesses and the wider economy. He believes that private companies in the oil industry may have a hard time with prices so low.

“Private upstream service companies need to focus on technological innovation to bring down costs for oil companies and promote their service efficiency. Downstream refineries must cut costs to survive. A low price is good for downstream oil companies, but weak demand on oil products and overcapacity downstream require companies to offer competitive prices. Low oil prices can restrain the healthy development of new or sustainable energies, but we need to look at this strategically in the long run,” he said.

“As China grows stronger economically, energy security must be considered. The growth of the new energy sector can help China with its overall economic recovery, increase investment, employment and GDP (gross domestic product) and help the country gain energy independence.”

 

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