For the past 9 months, the COVID nightmare has impacted every facet of our collective health, economies, political systems, and even social fabrics on a global scale. As of the date of this writing, there appears to be at least three viable vaccine candidates. While logistics in deploying the dosages to a world-wide population is the next hurdle, we’ve been told that the scourge should subside by spring, when a vaccine has been made widely available. But what if the cavalry is not coming? What if the COVID-19 pandemic, like the Spanish Flu, carries on for another 12 months, deep into 2021? The one constant throughout this experience has been an underestimation of the timelines involved – who can forget ‘two weeks to flatten the curve,’ or ‘it should burn out by late summer.’
I have great faith in the scientific community and deep gratitude for all those involved in manufacturing vaccines in record time. I’m hopeful that we’ll be back to stadiums for college football next fall. Given the recent experience and Murphy’s Law, however, it would be reckless at best for anyone involved in the oil and gas industry – particularly mineral owners – to fail to consider the ramifications of a prolonged continuation of the pandemic through 2021.
To be certain, COVID-19 has not single-handedly destroyed oil and gas prices. For a number of reasons, commodity prices were facing headwinds throughout 2019 and into Q1 2020. The emergence of the coronavirus and its knock-on effects, however, converted these headwinds into a collective hurricane. Throughout 2019, WTI averaged $57/bbl. A bare-minimum of sorts; just enough to keep the domestic industry going. Beginning with the virus’ emergence in the west in mid-February 2020, the ensuing societal lockdowns with their resulting collapse of economic activity and travel in almost all forms – air, automobile, etc. – saw the price of oil free-fall from the mid $50s to a historic low of ~ negative $40bbl in mid-April. Since that time, prices have recovered to an approximate $40bbl, or roughly 70% of their previous 2019 average.
Over the next several weeks, we’ll take a deeper dive into what a prolonged pandemic could mean for the oil and gas industry, and mineral owners in particular. First, let’s be clear that baked into the present price is the expectation of economic recovery. So what happens if the recovery materializes much later than expected? Let’s follow the linear progression…
1. Demand remains artificially depressed
The price of oil is driven by many factors that can be roughly bundled into two buckets – relative scarcity of supply in one and demand driven by economic activity in the other. The coronavirus has not materially impacted the supply side of this equation; that is, the coronavirus has not curtailed our ability to produce oil and gas.
What we have witnessed is catastrophic demand destruction; we are not using anywhere close to the amount of hydrocarbons that we were one year ago. In looking forward to what another ‘lost year’ might mean due to a continuation of the pandemic through 2021, it is critical to distinguish between pandemic-related artificial demand destruction and structural demand destruction wrought by changes to consumer behavior. In the present case, while there are accelerating trends towards non-hydrocarbon energy sources, the key driver of the current demand destruction is artificial – we are experiencing an externally forced temporary change or limit to consumer behavior tied directly to the coronavirus. Due to short-term (i.e. until the virus threat subsides) government restrictions and/or health-driven choices in direct relation to the virus, people are not allowed – by either mandate or choice – to behave as they once did and will do again. Simply put, they may not move around or congregate as they would like, and thus are using far less hydrocarbons than they would if given the ability to behave as they would like.
Demand is thus artificially constrained by the coronavirus. People are not able to go to restaurants, large social gatherings, business meetings and conventions, or vacations; they have not replaced these behaviors with other more preferred experiences, nor have they changed their means of moving from one place to another. They are not going to restaurants, traveling to Mexico for vacation, or flying to New York for Christmas shopping either because the government has prohibited it or because they are concerned about contracting COVID.
This distinction is critical in that it is separate and distinct from an intentional consumer-driven shift in behavior. People have not replaced travel with some other experience, nor have they replaced their means of moving from place to place. Clearly, there will be lasting modifications consumer habits – we may order more products on Amazon or work from home more often. However, there is no indication that once the artificial constraint on behavior – COVID – is removed, that people will not gleefully return to pre-pandemic activities such as travel and socializing.
Thus, while the temporary alteration of consumer patterns may accelerate some portions of renewable energy, the underlying demand fundamentals for hydrocarbons are there, they are just artificially depressed/constrained. When the virus threat is mitigated, either due to vaccine or our ability to ‘live with it’ (whatever that means), consumer-driven demand for hydrocarbons will return. Most economic models predict this will occur in late 2021; an extended bout with the virus should push this timeline proportionately.