Oil and gas after COVID-19: The day of reckoning or a new age of opportunity?
Ardak Nurazkhanov, Associate Partner, McKinsey & Company
The oil and gas industry is experiencing its third price collapse in 12 years. After the first two shocks, the industry rebounded, and business as usual continued. This time is different. The current context combines a supply shock with an unprecedented demand drop and a global humanitarian crisis. Additionally, the sector’s financial and structural health is worse than in previous crises. The advent of shale, excessive supply, and generous financial markets that overlooked the limited capital discipline have all contributed to poor returns. Today, with prices touching 30-year lows, and accelerating societal pressure, executives sense that change is inevitable. The COVID-19 crisis accelerates what was already shaping up to be one of the industry’s most transformative moments.
While the depth and duration of this crisis are uncertain, our research suggests that without fundamental change, it will be difficult to return to the attractive industry performance that has historically prevailed. On its current course and speed, the industry could now be entering an era defined by intense competition, technology-led rapid supply response, flat to declining demand, investor scepticism, and increasing public and government pressure regarding impact on climate and the environment. However, under most scenarios, oil and gas will remain a multi-trillion-dollar market for decades. Given its role in supplying affordable energy, it is too important to fail. The question of how to create value in the next normal is therefore fundamental.
Short-term scenarios for supply, demand, and prices
Under most best-case scenarios, oil prices could recover in 2021 or 2022 to precrisis levels of $50/bbl to $60/bbl. Crude price differentials in this period are also likely to present both challenges and opportunities. The industry might even benefit from a modest temporary price spike, as today’s massive decline in investment results in tomorrow’s spot shortages. In two other scenarios we modeled, those price levels might not be reached until 2024. In a downside case, oil prices might not return to levels of the past. In any case, oil is in for some challenging times in the next few years.
Regional gas prices could fall much lower than in the previous megacycle. Shale gas has unlocked abundant gas resources at breakeven costs less than $2.5/MMBtu to $3.0/MMBtu. The pandemic has had an immediate impact, lowering gas demand by 5 to 10 percent versus precrisis growth projections. With North America becoming one of the largest LNG exporters by the early 2020s, and a sharply oversupplied LNG market, regional gas prices in Europe and Asia will be driven by prices at Henry Hub, plus cash costs for transportation and liquefaction (a premium of about $1/MMBtu to $2/MMBtu).
Demand for refined products is down at least 20 percent, and has plunged refining into crisis. We think it will be two years at least before demand recovers, with the outlook for jet fuel particularly bleak.
The immediate effects are already staggering: companies must figure out how to operate safely as infection spreads and how to deal with full storage, prices falling below cash costs for some operators, and capital markets closing for all but the largest players.