How the coronavirus pandemic is debunking some long-held myths of the energy industry

The Well-Safe Guardian plug and abandonment rig, operated by Well-Safe Solutions Ltd, stands in the Port of Cromarty Firth in this aerial view in Cromarty, U.K., on Tuesday, June 23, 2020.

Jason Alden | Bloomberg via Getty Images

The coronavirus pandemic has exposed some hard truths to the world’s largest oil and gas majors, energy analysts have told CNBC, with many reeling after historic second-quarter losses laid bare the financial frailty of the industry.

“Big Oil” companies, referring to the world’s largest oil and gas firms, posted huge losses in the three-month period through to June as coronavirus lockdown measures coincided with an unprecedented demand shock.

The results were expected to mark the low point of what has already been touted as potentially the worst year in the history of global oil markets.

The devastating economic impact of the coronavirus outbreak has prompted energy majors to slash shareholder distributions, rack up increasing levels of debt, and sell or write-down the value of their assets.

The chief executive of Saudi Aramco, Amin Nasser, sought to reassure market participants about the outlook for the energy industry earlier this month.

Speaking during an earnings call with investors shortly after the world’s largest oil company posted a 50% fall in profits for the first half of its financial year, Nasser said: “The worst is likely behind us.”

Yet, as energy industry peers warn of significantly lower oil and gas prices through to 2050, others are not so sure.

The petrochemicals bet

“I like to look at the financials, and the picture has been bleak for this industry for a decade,” Kathy Hipple, an analyst at the Institute for Energy Economics and Financial Analysis (IEEFA), told CNBC via telephone.

The beleaguered energy sector has fallen 36% year-to-date, making it the worst-performing sector on the S&P 500.

The sector has consistently disappointed investors since 2010, Hipple said, with oil and gas companies clearly finding it “increasingly hard” to raise enough cash flow from their operations to cover shareholder distributions.

Instead, many cash-strapped energy giants have opted to dig themselves further into debt or sell off their assets in order to cover dividends or share buybacks.

“That is financially unsustainable,” she continued. “You might be able to get away with that from time to time but that is certainly not a long-term strategy to run a business.”

One myth of the energy industry exposed by the pandemic, Hipple said, was the idea that oil and gas companies would be able to profit from petrochemicals. These are derivatives of oil and gas production used to make things like plastic, pesticides and fertilizers.

The sector is widely regarded as a key driver of oil demand growth in the coming decades, offsetting a decline in the demand for motor fuel.

“We call it the last frontier for the oil and gas industry,” IEEFA’s Hipple said, specifically referring to the pivot to petrochemicals.

“I would say that even before this crisis, it was a poor bet,” she added, citing too much competition, an oversupplied market and overbuilding globally. The “already distressed” industry has since been ravaged by an unparalleled demand shock.

BP abruptly announced late last month that it had agreed to sell its global petrochemicals business to Ineos for $5 billion. The move, which BP CEO Bernard Looney conceded would have “come as a surprise” to many, was designed to ensure the company could “compete and succeed through the energy transition.”

The U.K.-based company has since announced a new strategy that it says will help the firm shift to clean energy in line with its plan to become a net-zero-carbon company by 2050 or sooner.

‘Asian tooth fairy’

The so-called “Asian tooth fairy” is another myth thought to have been exposed by the pandemic. It refers to the idea that Western crude producers, particularly in the U.S., would always be able to rely on an apparently relentless appetite for energy from Asia.

Earlier this year, Shell, citing third-party forecasts, predicted global demand for LNG (liquefied natural gas) would double by 2040. The Anglo-Dutch energy giant said the U.S. — the world’s fastest-growing LNG exporter — would see export growth skyrocket by 340% over the next 20 years.

Meanwhile, China — the world’s largest LNG importer — would see LNG imports jump by 116% over the same timeframe, Shell predicted.

Energy analysts told CNBC the coronavirus-led demand shock had since “sped up the unraveling of this investment thesis.”

Tugboats push an oil tanker to the reception terminal in Qingdao in east China’s Shandong province Sunday, Aug. 04, 2019.

YU FANGPING | Barcroft Media via Getty Images

“The U.S. fracking buildout and the LNG buildout, in particular, was premised on this unlimited demand from Asia for LNG and prices that would give U.S. LNG companies a profit,” Clark Williams-Derry, energy finance analyst at IEEFA, told CNBC via telephone.

Liquefied natural gas was seen to be tipping into oversupply last year, Williams-Derry argued, adding the coronavirus crisis had now flooded the market to a point where the glut had become impossible to ignore.

“LNG prices are now far too low for U.S. exporters to make any profit, prompting many to simply shut off,” he continued. “It is not so much that the coronavirus crisis is going to last for a long time, it is more that the ‘new normal,’ post-Covid, may be one in which the U.S. LNG export dream seems out of reach.”

The demise of Big Oil is ‘probably overstated’

Not everyone is pessimistic about the industry’s prospects.

“The Stone Age didn’t end because they ran out of rocks,” Ron Smith, senior oil and gas analyst at BCS Global Markets, told CNBC via telephone, referencing a well-known quote from a former minister of oil for Saudi Arabia.

“The question is, in the near term, call it five to 10 years, is there anything on the horizon that can meaningfully replace oil as a transportation fuel? And, I have my doubts, let’s put it that way.”

“I think the idea that we are facing the imminent demise of Big Oil, or oil period, is probably overstated,” Smith continued.

He suggested that it may be the case oil prices slip to slightly lower-than-average levels over the coming years, citing threats to future oil demand growth and industry-wide innovations.

“But, I don’t expect a revolutionary destruction of the oil and gas industry any time in my lifetime,” he added.

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