Energy markets in the 1970s and 2020s: Is past prologue?

In the newest podcast by IHS Markit Energy and Natural Resources team, our experts explore the intersection of the financial and capital markets with the global energy industry. Listen to the fascinating conversation as Roger Diwan and Carlos Pascual compare global markets in the 1970s to the 2020s. Here's an excerpt from their conversation from our EnergyCents podcast:

Rachel Beaver:

So, Roger, I'm interested. Do you think that the oversupply we've seen in the last few years will continue to be a major focus for the oil markets in the decade ahead? Or, do you think we'll see oil prices back from production restraint in OPEC and elsewhere?

Roger Diwan:

Yeah. So I think this Seventies' prologues to the 'Twenties in oil doesn't really work. You had two supply shocks. Here we have the biggest demand shock ever. So, in many ways we're at a time of extreme abundance and, as we speak right now, we have about 16 million barrels per day of spare capacity, which is exactly contrary to what we had in the 'Seventies, no spare capacity and prices rising. So, I think we're in a different moment. The question that you're asking here is, "Is this moment where we create so much pain that we have not enough investment in the industry to meet demand two, three, four years down the road in a post-COVID recovery golden age?" Not '75 as you're on, but more like the early 'Sixties and the 'Fifties where everybody goes out and starts spending money and you had a big boom, an inflationary boom, if you want.

I don't see that. I think the industry right now, and the abundance of resources that we have, means that oil prices in the medium-to-long term are capped, actually, because at $60/$70 we can deliver a lot of resources. So, oil is not likely to be the source of inflation and energy in general. Actually, I think, it might be a source of deflation. Carlos, what do you think about that?

Carlos Pascual:

Well, I would say that the story of the 2020s is going to be the story of demand, as opposed to what it was in the 1970s, which was the shortages of supply. And I think, Roger, that our views coincide with one another, but the critical issues that we're going to see …shat we see right now with the pandemic is that you've had a massive contraction of demand because of the inability to drive, to move, for the economy to function, to people being engaged economically. And, as a result of that, it's had a huge contraction on GDP. It's had a huge impact on oil demand. And, the recovery is going to depend on how we get out of that pandemic and how demand in the world resuscitates itself again.

But that's going to transition and other issues: When is peak demand going to occur? Is energy transition going to be accelerated as a result of this process? Are people going to begin to see that there is an inevitability of change and start to embrace it? How is ESG going to play into these questions? And so I think that the story that we're seeing evolve right now is a story of what is the demand for energy going to be in the future? What is the mix of that energy going to be? And at what point do we start to embrace change? Do we recognize that this change is inevitable and you embrace it and then, potentially, accelerate that transition process even further?

Rachel Beaver:

That's really interesting to hear you say that, Carlos, because I wonder whether ... I mean, obviously, environmentalism is an issue that was around in both decades, in both eras. In the 'Seventies the US observed Earth Day for the first time in April 1970. Nixon created the Environmental Protection Agency later that year and, as you've highlighted, ESG concerns continues to be high on the agenda in the 2020s and continues to be influencing policy. But I think, importantly, do you think investors in traditional energy companies share the same environmental priorities?

Carlos Pascual:

Well, the first thing I would do is question the wording "traditional energy company" because that's one of the things that's fundamentally changing. If you look at the international oil companies: Repsol, BP, Shell, Total, have all made commitments to net zero carbon emissions by the year 2050. That's going to mean that they're not going to look traditional after some period of time. Oil and gas is going to be part of their future for some period of time, but new things are going to come into it, and then Equinor and Eni have also made extensive commitments. The US oil and gas companies are not in exactly the same space. So, I think that's one piece.

The second piece of it, when you come back to the point of investors, and here I want Roger to jump in, what struck me is that investors in the end are thinking about the return that they get, but they're also thinking about volatility. And one of issues that we've seen in the past decade and we see a major concern right now, is the concern about price volatility. They want dependability. And so I think there's also going to be pressure out of investors, out of concerns that they traditionally have, that this price volatility is not good for what they're trying to do with their investment funds. And so I think we're going to see changes from both sides. Companies are going to change, investment patterns are going to change, and the interesting question that we come back to is this point that I've been thinking about a lot, is when does it get to the point where you just start hugging this, right? Because this change seems so inevitable that you feel like you have to embrace it and go with it.

Roger Diwan:

Well, we are at the moment of embrace, correct? I mean, major oil companies talking about, "net zero." This is the embrace. And I think the embrace is coming, not only out of... this is what their shareholders are asking, et cetera, I mean, this is where the future is. Technology is shifting. They're in the energy business at the end of the day. They're not on the oil business. They need to think that they're here to deliver energy whatever form it is. The question is can they transform their portfolios to go there?

In terms of returns, as you said, Carlos, it's not clear over the last five, six years, even with the ... particularly with the shale revolution, that the returns in the oil business has been better than any other aspect of the energy chain even with lower returns like certain renewables, et cetera. But even that now, I think, would be debatable, which is what we just saw. So I think from delivering values to their shareholders they're going to need to find new business models, and oil is not the slam dunk that they had to make an arbitrage between, "Let's make money with oil or be green." That bargain doesn't exist anymore. Shale has transformed that, the peak in demand, all of these issues, technology and bringing oil to the surface at $35/$40 in the United States, et cetera, et cetera, changed that debate.

But, at the same time, I think, you can't have these companies too unmoored from their societies, correct? I mean, their shareholders are pensioneers at the end of the day, and pensioneers also have values, and I think what we're seeing, with the rise of the ESG investing, how these companies present themselves, how they present their carbon footprint, how they appeal to new generation. I mean, talking to my kids about these companies, when you say, "Oil," it's a dirty word, correct? So that has to also evolve with society.

So I think it's both an issue of values and value that they will have to transition, and it's happening. The important transition for me is really happening on the capital markets, correct? I mean, this is where the pressure is coming from. It's not coming from the government in the United States. It's coming from the financial side of the business putting pressure on oil companies, saying, "Look, you don't see the criteria that are for companies that we want to invest in, in terms of returns, but also in terms of your ESG footprint." So that changes then that capital transition is actually happening probably faster than the transition in the energy mix that already exists within these companies.

Carlos Pascual:

And just one thing I would add to that just on the national oil companies, I mean, one of the fascinating things is that, look at the Middle East. The intent has been to use oil to reduce dependence on oil, right? To create the financial resources to facilitate diversification. And one thing I would say is watch sovereign wealth funds from the oil producing States. Watch how many of them are going to be investing in oil related activities. I bet you, even in those sovereign wealth funds, what you're going to see is a real change in their investment patterns.

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Carlos Pascual is Senior Vice President, Global Energy at IHS Markit.

Roger Diwan is Vice President, Financial and Capital Markets at IHS Markit.

Posted 19 June 2020

This article includes information from an audio conversation and has been professionally transcribed as accurately as possible. Some words or phrases may have been unintentionally excluded.

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.