(Bloomberg Opinion) -- The big question haunting oil is how much Covid-19 has changed the world. Will more people give up on commuting or, conversely, drive into work? Has air travel peaked for good? Have Londoners and Angelenos been spoiled by a few haze-free months?
Judging from the past week, though, maybe oil’s real problem is the world hasn’t changed enough.
Last year, the big challenge confronting oil demand was the trade war. This eased somewhat in January with the “phase one” agreement committing China to buy more U.S. exports, including extra freedom molecules of energy. Even then, however, most of President Donald Trump’s tariffs were left in place, and sensitive issues such as Chinese subsidies were deferred. It was more ceasefire than treaty.
The guns are silent no longer. China’s decision to effectively lop off the second half of Hong Kong’s “one country, two systems” rubric was met with Secretary of State Michael Pompeo’s announcement the U.S. would take Beijing at its word. No longer recognized as autonomous, Hong Kong’s trade could be hit with tariffs, and the U.S. could even impose sanctions.
More importantly, this is a tangible breach after months of escalating tension, with tit-for-tat expulsions of journalists and Trump even floating the idea of China being “knowingly responsible” in the spread of Covid-19. The phase one agreement, meanwhile, was off to a slow start, with China taking just $14.4 billion of goods listed under the deal in the first quarter, versus the $34 billion implied by the targets, according to Bloomberg Economics.
With November looming, and his presidency tainted by America’s Covid-19 death toll and joblessness, Trump may well have decided China makes a better pandemic scapegoat than economic buttress. But antipathy to Beijing extends beyond the president. In the same week Pompeo opened the door to sanctions over Hong Kong, the Democratic-controlled House voted almost unanimously to authorize sanctions against China for human-rights abuses against the country’s Uighur minority. For reasons extending back much further than the existence of the Chinese Communist Party, such prods into the country’s internal affairs will touch a nerve, potentially escalating a trade dispute into broader great-power rivalry.
The unraveling of free trade has been apparent since at least the 2016 presidential campaign. As I wrote here a few years ago, this is particularly pernicious for an oil market built on the back of globalization and U.S. security guarantees.
Far from provoking mass kumbaya in the face of a common enemy, Covid-19 elicited a more Darwinian response, even between supposedly united states. Besides attempts to tattoo a flag on the virus, its arrival threw a spotlight on countries’ vulnerability to shortages of imported medical supplies, providing fodder for economic nationalists seeking re-shoring and a general shortening of supply chains. Fragmentation means friction, which tends to suppress growth over time. In projections published last year, BP Plc ran a “less globalization” case that took a hefty chunk out of forecast oil and natural gas demand; in the latter case, even more than for a scenario of quicker de-carbonization.
The world also hasn’t changed as much as it might seem when it comes to oil supply, either. The coronavirus world tour coincided with the breakdown of Saudi-Russia cooperation on production cuts — and then facilitated a rapid rapprochement as oil prices headed toward negative territory. The swinging supply cuts forced on OPEC+ members, along with signs of congestion resuming in Chinese cities especially, helped drag oil back into the $30s this month.
But the underlying dynamics haven’t changed altogether. Russia has implemented big cuts but is reportedly keen to start unwinding these sooner rather than later. As when it broke with OPEC+ in March, Moscow is done ceding market share to U.S. frackers. The latter have cut production very quickly, but their instinct to get rigs and crews back to work remains strong. Holding them in check are low prices, particularly for longer-dated futures, weighed down by the glut of physical oil and spare OPEC+ capacity that’s built up over the past couple of months. Shale does at last seem poised for rationalization. However, supply’s defining characteristics of the past four years — excess inventory and OPEC+ versus shale competition — are for now accentuated rather than altered.
Similarly, the International Energy Agency’s latest investment report, which dropped this week, was consumed with Covid-19 yet trod familiar ground. This showed the theme of excess supply extending into refining, where too much capacity was opening even before the pandemic showed up.
Above all, that other force of nature confronting energy markets, climate change, pervaded the discussion. If anything, the pandemic is a reminder of why we should be tackling that threat head-on. Covid-19 has both spotlighted the risk and, if stimulus efforts are shaped properly, may catalyze a response. With uncanny timing, at Chevron Corp.’s (virtual) shareholder meeting this week, the only measure where a majority of investors voted against the board concerned aligning the oil major’s lobbying with efforts to address climate change.
There is still so much we don’t know about the lasting impacts of Covid-19 or, indeed, the workings of the virus itself. One thing that seems clear, however, is its tendency to magnify pre-existing conditions. For oil, those were excess supply, fraying globalization and a looming climate emergency.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.
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