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Oil sector grasps for answers amid plummeting prices, COVID-19

Don Horne   


No industry is immune from the impacts of COVID-19, including oil. With news that oil demand is down 20 per cent as a result of the virus, everyone is looking for solutions as to how to weather the current crisis, and how to turn things around.

Arij van Berkel

Lux Research Director Arij van Berkel spoke with Don Horne of PROCESSWest on what the industry is experiencing, and what it can do to come out the other side.

PROCESSWest:     The crash in oil prices is obvious to everyone. What sort of effect is it having on the industry?

Van Berkel:      The oil and gas (O&G) industry has dealt with low oil prices before, so they have their playbooks ready. They will cut back on investments and try to maintain their workforce as much as they can. However, this time around they do face a dilemma as to how to cut back on investments. Most O&G companies now have significant investments in exploration (finding more oil and gas) as well as in “new energy,” which is mostly solar and wind energy but also investments in batteries and even in buying utilities wholesale.


PW:     What effect is it having on Alberta’s oil sands sector?

van Berkel:      In the past the industry has always prioritized oil and gas, so the cost cutting would primarily affect the new energy business. This time it is different. It is the first time that there is an actual decrease in demand, so why find new oil if demand is decreasing? On top of that, there’s also a consensus in the industry that demand will eventually start to decrease structurally and that will happen about 10 to 15 years from now. Therefore, it is much more likely that the industry will make different choices this time than they have in the past.

PW:     What can the oil and energy sector do now to adjust?

van Berkel:      The Alberta oil sands sector has made great efforts to reduce the WTI-equivalent break-even prices in the past five years. The price went from about 70 US$/bbl in 2014 to about 50 US$/bbl. This has been achieved through many incremental improvements in among others energy efficiency, labour costs and equipment costs. It will be hard to reduce break-even costs even further rapidly as all of the low-hanging fruit has been plucked already.

The market price for WTI oil is hovering around US$ 25, so the Alberta oil sands are losing about US$ 25 with every barrel produced. They can stomach those losses for some time, but it is obviously not a sustainable business operation and it will have an immediate impact on all investments. All investments will likely be suspended and that includes investments in expanding pipeline capacity.

The industry’s response is to reduce investments, starting with investments in high break-even wells and potentially also in exploration. It is interesting to see if the companies will continue to prioritize investment in renewable energy. This would make much sense in the current circumstances. The return on investment in renewable energy is similar to that in oil or gas right now and renewable energy has a much more robust outlook. The industry had already been working hard to improve efficiency and drive down break-even prices across the board. Those efforts will need to be accelerated now.

PW:     How long will these prices last?  What will be the lasting effect on Alberta’s oil and gas sector?

van Berkel:      I cannot tell you how long these low prices will last. The root cause was the increase in production by Russia and Saudi Arabia and that was mostly a political issue. Of course, this has now been compounded by the low demand due to COVID-19. While the virus-related restrictions last, the world is building up a stock of unconsumed oil products. Consuming that stock will take approximately the same time it took to build it. So, I would expect the impact of COVID-19 on the industry to last at least until September and perhaps even for the rest of this year. The impact on the oil sands industry will be a lack of investments. Such a lack of investment for 12 or 18 months will not have much lasting effects but if this lasts longer, there will be a lasting effect as stakeholders pull out of the business entirely.

PW:     In future, how can the industry insulate itself from any future challenges like these?

van Berkel:      The oil industry cannot easily isolate itself from event like the price war and COVID-19. The only way would be through trade barriers, but these are almost impossible to implement for energy. Energy prices affect every other aspect of the economy and artificially high energy prices in a country through trade barriers will thus have a huge negative impact on the country that imposes them. The other “cure” for this illness is to have the lowest break-even prices in the world. This is why Russia and Saudi Arabia hold this position of power. They can stomach the lowest oil prices. The industry is doing precisely that: trying to reduce break-even prices. As mentioned before, this happens with small gains in many aspects of the production chain. It is possible that a very ambitious, moonshot type, program can make a difference. That would need to aim at fully automated drilling and production for example. However, I would not advocate for such a program. There are other investments in renewable energy for example that make a lot more sense currently.

PW:     What can Canada do to attract investment in its oil and gas sector? And how have protests and federal policies hurt investment?

van Berkel:      In general, it is important to provide a stable policy and outlook. In particular, Canada should ensure that there are good mid-stream facilities such as oil pipelines. Another area where a long-term commitment is required is environmental regulation. It’s not bad to have strict environmental regulation per se, as long as the policy is steady, predictable and reliable.

You can also see this article in the online May issue of PROCESSWest magazine.


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