By Michael Maher, Ph.D.
Senior Program Advisor for the Center for Energy Studies
Anna Mikulska, Ph.D.
Nonresident Fellow in Energy Studies
“Happy economic times are all alike, every recession is unhappy in its own way.”
—A slight modification of Tolstoy
For oil markets the 2020 story is not as much about supply as it is about demand, or rather it’s lack. To be sure the oil price war between Saudi Arabia and Russia rocked the markets. But soon it became clear that there is not enough demand for the additional volumes that either country wanted to produce. Hence, the relatively quick end to a Russia/OPEC standoff. Even so, an oil price decline followed because of the continuously steep oil demand drop. While in recent days we have seen prices nudge up a bit on the basis of positive economic forecasts, we are all still largely unsure whether the latter will actually occur much less when oil prices might return to the $50-60 range from before the pandemic.
The uncertainty is driven by the fact that the economic downturn has not been caused by a typical economic weakness but rather by external factors: a pandemic and governments’ response to the pandemic, neither of which conform with past economic recessions or recovery efforts. Those factors make modeling of the economic future extremely problematic. Forecasts of economic activity and oil demand, whether national or international, are flying blind because, as the joke goes, models are really good at forecasting recovery from the previous recession; from a current one, not so much.
Hence, rather than trying to give you a forecast that may either overstate or understate the damage that COVID-19 may inflict on the U.S. and global economy, we want to highlight what to look for as this pandemic progresses, recedes, or oscillates while pointing to high level of uncertainty surrounding any type of economic predictions. Two significant unknowns are: 1) how quickly and at what pace GDP growth will return leading to a rebound in oil demand and 2) whether responses to the pandemic have led to structural changes that permanently affect oil use.
Let’s set up the scene first
We are witnessing an unprecedented economic shock. The U.S. economy contracted at a 4.8% rate in the first quarter and the rate of decline is likely to be much higher in the second quarter of 2020. 40 million Americanswere out of work by the latter part of May. Even in Asia, world’s economic engine, growth ground to a halt, first time in 60 years. China’s GDP fell by 6.8 percent in the first quarter of 2020. IMF estimated that the growth will be at a meager 1.2% for 2020 and that is if China’s and the global economy pick up quickly. Japan’s GDP could fall by 5.2% in 2020. Other world regions have not fared much better. Russia’s GDP could fall by 5.5%, Italy’s by 9.1%, and Germany’s by 7.0%. Challenges of the rolling pandemic are now affecting Africa and South America. Of course, all the numbers for future growth – or lack thereof – are tentative as the world operates under unprecedented scenario and the concern about the the virus returning in the fall or winter adds significant level of uncertainty.
As expected, the economic slowdown has and will impact energy demand and energy prices.
Under a typical economic recession scenario, one would expect low prices of energy to have a positive impact on demand. All else equal, the drop in the price of oil becomes a stimulant for growth of gasoline, diesel and jet fuel. But price elasticity of demand assumes unchanged income and economic activity, consumer and businesses choices and risk preferences. So far, this has clearly not been the case. An unbelievable 4 billion out of 7.8 billion of the world population was under some sort of economic lockdown or social quarantine in late April.
Low oil prices cannot do anything to encourage oil demand when people are not allowed to drive to work, fly for business; when they cannot earn the same income or become unemployed; and when industries have to cutback or worse, shutdown. Hence, even under record-low prices, oil demand has suffered as economic lockdown and travel restrictions seriously reduced need for all transportation fuels. In the U.S., on April 22, 2020 only 93,000 passengers passed through TSA check points vs. 2.2 million last year. Compared to mid-January, 50 million fewer people were riding inter-city buses in China in April. In the UK, in April 9 out of 10 flights were grounded. Valencia, Spain’s 3rd largest city, experienced tourists’ hotel cancelations of 95%.Gasoline purchases have also been down. In the U.S. gasoline demand has been lowest since 1969.
All in all, the IEA forecasts that global oil demand in April could fall 29 MBD year-on-year followed by 26 MBD in May, 15 MBD in June, and a drop of over 9 MBD for the entire year.
Where will the recovery come from?
The most important driver of oil demand in the next few years will be the pace of economic recovery worldwide. This time, however, new factors could slow or accelerate that recovery, including a prolonged level of uncertainty.
To begin, as opposed to the recovery that followed the 2008-2009 recession, we now cannot count on China and Asia as a global recovery driver. China’s average GDP growth during 2008-2013 was 9.1 percent and the country’s oil consumption grew by 5.7 MBD, by 2018, a long cry from their expected growth path going forward. Nonetheless – even if at initially reduced levels – the developing world, not the OECD, will continue to lead demand growth. Even in the U.S., despite generally successful economic recovery and good economic performance in recent years, per EIA, U.S. oil consumption in 2019 had not yet returned to the pre-2008 peak.
But while longer term (consistent with pre-COVID19 trends) we will look for oil demand growth in the developing world, short term that demand could be significantly impeded, not least because of the fact that developing countries’ governments have fewer resources to dispatch to help their ailing economies.
Much will depend on: 1) how successful they will be in pleading to the IMF, the World Bank or the OECD for help with debt relief or additional loan support and (2) how fast international trade picks up to support their export sectors.
In contrast, in the developed world, government stimulus activity is in full swing. In the US, an unprecedented stimulus of nearly $3 Trillion with possibility of hundreds of billions more on the agenda. Europe has devised a stimulus plan of around $830 billion as well.
That said, despite astronomical amounts funneled into countries’ economies, it is unfortunately unclear how effective they could be. After all, predictive power of any forecast will be impeded by lack of precedent when it comes to both COVID-19- related economic downturn as well as extent of the stimuli.
To start, effects of any stimulus will be definitely challenged by the bankruptcies that are now occurring in tourism, dining, in-store shopping, etc. which will protract the recovery in those sectors. Some businesses will never return and will never be replaced due to changes in consumer and business behavior and risk preferences.
The big question is, how permanent and how extensive will the COVID-19-related changes in behavior be? We expect lots of them will eventually cease, particularly if the disease disappears quickly and or an effective vaccine is developed soon. However, some changes may become entrenched and, as such, will affect energy/oil demand long-term.
Are we going to be more likely to shop online not only for clothing but also for groceries now and does on-line delivery lead to more or less transportation? Are we going to be more likely to work remotely, if not all the time, at least part of the time? And if we commute to work, will we be more likely to use our cars rather than public transit to ensure physical distancing? Or maybe smaller cities and suburbs will become more attractive than densely populated cities relying on mass transit like New York? Will businesses be more likely to continue to organize zoom meetings, rather than flying to often far-away destinations? We are also not sure how fast will incomes be able to recover and how this will impact consumers’ decisions with respect to airline, cruise, and leisure travel as well as vehicle purchases.
Lastly, the recovery in the demand for fossil fuels may be affected by climate change considerations, though – just like seemingly everything in the post-COVID19 world – the details here are also uncertain. A lack of international cooperation has been reinforced by the pandemic as has growing political distrust of global supply chains and international trade. The discord is not a cause for optimism for any worldwide cooperation. On the other hand, we see a strong push by the European Union, proposing to combine its economic stimulus with an aggressive green new deal. This includes, “climate” tariffs that beyond their direct effect can also disrupt trade and slow global growth and consequently slow down global energy demand. If the U.S. presidency changes hands in 2021 we will likely see more “green” policies on the agenda, though record-high budget deficits expected in the upcoming years may limit government funding and subsidies. In the developing world, slower economic growth may reduce their interest in strengthening climate commitments while potentially persisting low fossil fuel prices could encourage even faster growth in use of those fuels.
*This blog follows up on our April 24th webinar “Challenges to oil Demand Recovery in the Post-COVID-19 World.” You can access this and other CES webinars here.
This post originally appeared in the Forbes blog on June 10, 2020.