At present there is no shortage of public discourse about the death of fossil fuels in general, and oil in particular, in the wake of the Covid-19 pandemic. Unquestionably, the pandemic has resulted in near-term crude oil demand destruction on a scale the market has not seen before.
Prior to the emergence of the pandemic in March, global oil demand projections for 2020 stood at around 100 million barrels per day (bpd), with demand growth projections in the range of 1.1 to 1.3 million bpd.
Subsequently, with Covid-19 at its height in April, came projections of annual demand declines of as much as 20 million bpd with airlines grounded, vehicles parked firmly in driveways and whole economies in lockdown. Inevitably, value destruction in the oil and gas sector followed as the likes of BP, Shell and Total moved to write-down the value of billions of dollars worth of their assets.
Of course, many of the premature criticisms, or shall we say obituaries, of fossil fuels have been penned whist pointing a finger at the lackluster price of oil with both Brent and WTI lurking well below $50 per barrel so far into the third quarter of the year. And of course, who can forget the short-lived but infamous dip of the latter contract into negative prices back in April.
Given that major global economies are limping back to normalcy, neither did the dire forecasts for oil demand materialize nor will the premature projections of the industry’s imminent decline. The International Energy Agency (IEA) now sees global oil demand for 2020 at 91.1 million bpd, reflecting a fall of 8.1 million bpd year-on-year on pre-Covid19 growth projections.
That’s still pretty bad and equates to a wipe out of nearly a decade’s worth of demand growth in 2020. However, the real reason why oil futures aren’t providing market bulls with much comfort is not down to historic demand slumps but rather anxiety over the state of the aviation sector, and lower petrochemical products take-up.
Aviation in particular was the fastest growing segment of fuel consumption within the mobility and transportation segment pre-Covid. While the electrification streak of ground transportation – OECD economies excluding – is nowhere near as fast as some would have you believe, aviation has no obvious, immediate and viable alternative source to jet fuel cracked from crude oil.
Of course, the pandemic is pretty abnormal and has made aviation among the one most disproportionately affected sectors powered by oil and it matters. Nearly 8% of headline crude consumption in 2020 was by the aviation sector, and it was posting the fastest growth rate of any consumption segment both generally, and within the human mobility spectrum which accounts for 49% of all oil consumed.
But with some of the biggest names in the airline industry operating at 20% capacity, others fighting bankruptcy, new airplanes mothballed, older aircraft heading for scrapyards and thousands of job losses – things appear bleak. They may stay that way for a while yet in the eyes of some, including the boss of London’s Gatwick airport who recently noted that it could be nearly half a decade before airline traffic returns to pre-Covid-19 levels.
This negative sentiment is reflected in the price of aviation fuel. According to IATA/S&P Global Platt’s jet fuel price monitor, a barrel in Asia & Oceania – one the biggest pre-Covid centers of demand – cost $42.08 on August 28, 2020, down nearly 45% on an annualized basis.
Map the jet fuel price trajectory against the price of Brent (see chart above) and you’ll see how closely both are intertwined, and why the price levels of both aren’t going anywhere fast. For good measure, on August 28, 2020 Brent’s November contract traded at $45.05 per barrel, barely up on the August 7 level of $44.71 that the previous contract was averaging. Ironing out weekly volatility, that’s an upward crawl of 34 cents or 0.76% in month of tracking.
What’s more, six-month forward contracts don’t yet offer much room for encouragement either, with the Brent May 2021 contract trading around $47.50 per barrel in late August. That’s hardly a contango level worth perking anyone up.
But a vaccine along with a projected recovery in 2021 could change all that and those betting on it are cognizant of that. For instance, hedge funds pocketed $1 billion in short positions against travel stocks in the first seven months of 2020, according to Ortex Analytics whose findings were cited by Reuters.
Bets against German carrier Lufthansa alone netted short-sellers more than €150 million ($172 million) over the said period. Put it together with the lackluster feel to the crude market and here’s the short-term ammunition predicting the demise of oil.
More so, because at the moment so-called second waves of Covid-19 are doing the rounds around the planet with clusters of fresh infections even in countries that managed the pandemic better compared to their peers. With no clarity on when a possible vaccine might provide relief, aviation demand will remain in the doldrums.
Figuratively speaking, prior to the emergence of the pandemic, global demand for aviation fuel was averaging around 8 million bpd. Come the end of 2020, a fourth of it could be wiped out, with Q2 and Q3 being the worst on record for demand, despite some minor encouraging signs in recent weeks.
Looking 6 to 12 months out, a wider oil market recovery from Covid-19 disruption is likely to be gradual even if there is a vaccine within the next two quarters, as economic activity picks up in Asia and the U.S. And that recovery will likely be “uneven” to quote Moody’s MCO with the pandemic unsettling long-term energy consumption patterns and heightening volatility in energy prices.
One thing I firmly believe is that barring the odd uptick of the U.S. driving season, if there is one this year, cheap fuel prices won’t spur demand for refined products. That would depend on economic growth and the strength of the markets for particular refined products.
So does a different story await us in 2021? Probably so! But until there is clear indication of that, oil prices are likely remain sub $50 per barrel, and will continue to oscillate in the $40-50 per barrel range dragged lower by an aviation sector with clipped wings.
Disclaimer: The above commentary is meant to stimulate discussion based on the author’s opinion and analysis offered in a personal capacity. It is not solicitation, recommendation or investment advice to trade oil and gas futures, options or products. Oil and gas markets can be highly volatile and opinions in the sector may change instantaneously and without notice.