Still in the midst of the COVID-19 pandemic, the oil industry is beginning to ponder the long-term consequences of a sudden halt in global economic activity and whether it might bring forward oil's long-term decline.

There are signs the oil market is past the worst part of a crisis that erased an estimated one-quarter of global oil demand; sent oil prices to negative levels and oil equities into a tailspin; nearly overwhelmed the industry's storage infrastructure; and drove the industry to slash capital expenditures by tens of billions.

In February, before self-quarantine measures were adopted worldwide, analysts had expected that oil demand would recover quickly after temporary lockdown policies and warmer weather contained the spread of the new coronavirus, and that the broader economy and oil demand growth would resume its pre-crisis trend by the end of the second quarter.

Two months into the second quarter, new infections and deaths continue to climb, and there is broad consensus that the pandemic will continue to weigh on the economy until after a vaccine is widely available. And economists say the longer the crisis drags on, the greater the consequences for oil demand.

Economic growth's evolving relationship with oil demand

Prior to the pandemic, S&P Global Platts Analytics predicted oil demand, which had reached 100 million barrels per day in 2019, would grow annually by 1.5 million barrels per day through 2025 before slowing to 1.0 million bbl/d through 2030, eventually peaking by 2040.

That peak could shift 15 years earlier "if behaviors shift dramatically and permanently across all sectors in response to COVID-19," Platts analysts wrote May 5. But that scenario is "highly unlikely, particularly as some of these behavioral changes will have to overcome weaker fuel prices." In addition, many of the vehicles on the road today will still be carrying goods and ferrying passengers for the next decade and a half.

"Broadly speaking, a long-term slowdown in oil demand growth is in line with a 10-15 year time lag related to capital stock turnover," the analysts wrote. "As a result, there is still a substantial rate of near-term strength built into oil demand based on the current capital stock, as well as the trajectory of the post-pandemic economic recovery and low oil prices. … Beyond 2030, persistent oil demand growth is primarily driven by three end-use sectors: aviation, marine, and chemicals, with particular strength observed in the developing world."

In the long run, macroeconomic drivers such as population growth and GDP growth support oil demand, while technology that improves efficiency and offers alternatives to oil consumption reduces it. Platts Analytics found that adherence to the Paris agreement on climate change, with its goal of limiting global temperature rise by 2 degrees C above pre-industrial levels this century, would accelerate efficiency and technology improvements to reduce long-term oil demand by 50 million bbl/d.

Now economists and other industry experts are thinking about how COVID-19 might change this outlook.

For example, Mark Mozur, an analyst at S&P Global Platts Analytics said that in light of the pandemic, it is worth reevaluating past assumptions about the relationship between income and consumer spending habits. The pandemic has hit the air travel market particularly hard, and the industry says it could take years for the sector to recover.

"If your income goes up in a post-pandemic world, would you still pay to go on that vacation to the Caribbean?" Mozur said. "Then, if economic growth slows down as people pull supply chains out of China, if consumers are more cautious in general, or if there is another pandemic," it would compound that effect, he added.

More broadly, Marie Fagan, the chief economist at London Economics International LLC said May 27 that economic crises tend to have two effects on oil demand: "Demand can reset at a lower level or stair-step down, and it may also grow at a slower rate because income elasticities of demand are smaller."

Fagan's research points to a sharply lower intensity of oil consumption to GDP in developing countries than that seen over the period during which countries like South Korea transformed their economies to emerge from poverty.

In the 1960s, South Korea had been among the poorest countries in the world. By 1996, it joined the Organization for Economic Cooperation and Development and later achieved a per capita income comparable to that of Western Europe. Not only might the pandemic have reduced the oil intensity of developing economies, it also calls into question whether those economies will develop as rapidly.

Citing "weak political capital," Mizuho analyst Paul Sankey expressed doubt. "The forecasts of global oil demand growth are all subject to sustained economic growth from the poorest countries in the world," he wrote May 14. He said oil demand will have peaked in 2019 because he expects "rich country efficiency to over-balance poorer country demand increases" going forward.

Mark Finley, a former senior economist at BP, now a fellow in energy and global oil at Rice University, said in a May 20 interview that he has "long been sympathetic" to the idea that there will be an oil demand peak. Although the base decline rate of oil and gas production means the sector will require sustained investment to meet declining demand, even under scenarios that assume aggressive CO2-reduction policies, the question of the timing of peak demand raises an important strategic issue.

"If you think that eventually we're going to run out of oil demand, then that provides a real incentive for the people that sit on resources to find ways to monetize it, ... [to] sell it and not leave it stuck in the ground with no value for future generations," Finley said.

Before the pandemic, governments and corporations had outlined broad strategies to contend with an evolving energy landscape, including: the public float of Saudi Arabian Oil Co. as part of the Kingdom's effort to diversify its economy away from oil production; the Norwegian sovereign wealth fund's divesting from the upstream oil and gas industry; Royal Dutch Shell PLC's goal to become the world's largest power company by 2035; and BP PLC's low-carbon transition.

Fagan said the COVID-19 crisis brings the issues of industry consolidation and diversification away from oil to the fore. "Income and price elasticities ... matter less to oil demand than they did in the past," she said. "This ... implies flatter growth of oil demand, even when economies recover from a recession. ... Peak demand may be closer than it was projected before the crisis."

But significant uncertainty remains around how the long-term impacts of COVID-19 play out.

"Could it be peak oil? Possibly. Possibly. I would not write that off. But there are so many things we don't control, I genuinely don't know what the future looks like," BP CEO Bernard Looney told the Financial Times in a recent interview. "All I know is, it's uncertain. It's going to have volatility."

When economics fail

Spencer Dale, at BP, and Saad Rahim, at commodities trading and logistics firm Trafigura Group Pte. Ltd., are each chief economists at businesses that sit at the nexus of the global oil trade. They said the stay-at-home orders have forced them to come up with new methods of monitoring the oil market.

Dale estimated global oil demand may have fallen between 25 million and 30 million barrels per day as global lockdown policies peaked in April.

"We don't really know," he said. "The nature of the shock we're living through is totally unprecedented. And so the economic models we have to analyze what's going on aren't fit for purpose. So I think it will be many years before we know exactly what's going on at the moment."

As broken as economic oil demand models are, the timing and trajectory of the economic recovery remain the key uncertainty facing the oil market, Dale said. He referred to economic forecasts that have global GDP at or slightly above the 2019 level.

"Is that possible in a world where we may have second waves [of COVID-19 infections]? Even if we don't have second waves, in a world of social distancing, is it really possible to get back to the same level of output where we were in 2019," he asked. "The truthful answer is, nobody knows that, and that seems to be the big uncertainty rather than the oil intensity of GDP."

As the COVID-19 crisis abates, Rahim posited it will leave in its wake 6 million people in the U.S. structurally unemployed, higher than the peak of the last recession. "To me, there is going to be sort of a level that we get to and then structurally, it's going to be hard to move beyond that," he said.

Of the demand shock, Finley said: "it all comes down to how does this play out. How quickly does the disease progress through a naïve host of humanity? How quickly can a vaccine be developed? What are the trade-offs that different governments around the world will make in terms of opening and closing and balancing the economic and public health considerations. ... We don't know any of this."

At the heart of these questions rests an important theme: The economic growth assumptions that underlie long-term oil demand models may be too optimistic.

Richard Newell, CEO at Resources for the Future, a nonprofit economics and policy research organization, said Shell's outlook assumes 3% annualized GDP growth while the IEA assumes 3.4% annualized growth over a 20-year period.

"By the time you get out in 2040, the difference between the highest scenario and lowest scenario really is only 7%," Newell said during a May 20 presentation. "[Is] this range of economic growth uncertainty ... indicative of the range of uncertainty that we might actually expect looking forward? The economic growth hit that we've seen due to the pandemic makes that an even more relevant question to us."

Finley put it another way: "If the prospects for future economic growth are systematically or probabilistically too high, then so is future energy demand growth."

COVID-19 and the pace of change

Experts are also watching COVID-19's effect on trade and geopolitics.

"We see a real absence of international cooperation during this moment of global crisis," Meghan O'Sullivan, an international affairs professor at Harvard University's Kennedy School of Government said May 20, pointing to early efforts by wealthy countries to procure vaccine manufacturing for the benefit of their own citizens. "But then we see more conventional manifestations of nationalism: Doubling down on calls to reshore manufacturing, growing talk about protectionist measures, a lot of talk in the United States about the use of tariffs ... to punish China for its handling of the virus."

"All of this together amounts to a move away from globalization and some of the prosperity associated with it," she said, adding that either a "top-down" policy-driven or "bottom-up" market-driven energy transition is difficult to envision in a world where nationalism and protectionism drive the global economy.

Economic and fiscal challenges left in the pandemic's wake "could quite easily distract ... from pursing the climate change agenda that the world was on prior to COVID," BP's Dale said. On the other hand, he added that the crisis may awaken the world to the fact that "global threats do not recognize national borders."

"Scientists have been flagging the pandemic for ... years, and not many governments responded to that. And likewise, scientists are making very clear the danger of climate change," he said. "If they can [stimulate their economies] in a way which encourages a greener, cleaner use of energy, then we can actually use this as a way to accelerate the energy transition," he said. "But I don't think that's in the bag. … Those of us that want to achieve that need to fight ... to make sure that these longer-term global factors still resonate even as countries quite naturally turn more domestic and short-term in focus."

S&P Global Market Intelligence and S&P Global Platts are owned by S&P Global Inc.