A Climate-Change Silver Lining?

The International Energy Agency’s executive director, Fatih Birol, estimated on March 25 that global oil demand could fall by about twenty million barrels per day, a prediction that has now been revised up to thirty million barrels per day. This plunge in world energy use is unparalleled in both speed and depth, exceeding all other major crises of the last century — including the 1929 Depression and the 2008 global financial crash.

And just as energy demand is in free fall, world oil supplies look set to significantly increase following an announcement in early March that Russia and Saudi Arabia would remove limits on oil production levels. Combined with the effects of the pandemic, this “oil war” has pushed global oil prices to multi-decade lows, and left producers rushing to find storage space on land and sea for their oil, rather than sell it at a loss. With global storage fast approaching full capacity, some oil traders are actually now expecting producers to pay them for taking oil off their hands.

All of these factors have led analysts to forecast a record number of bankruptcies among oil companies for 2020, an eventuality that could imperil a range of important banks and financial institutions in a manner redolent of 2008. But what might this extreme shock to energy markets mean for the future of the fossil fuel industry, and the possibilities of ending oil dependency?

Some commentators have speculated that this might all be a little bit of good news in the context of the COVID-19 calamity. The pandemic could “kill the oil industry and help save the climate,” as a headline in the Guardian exclaimed on April 1, with the demise of many smaller oil producers, and the weakening of oil majors such as ExxonMobil, Royal Dutch Shell, and BP bringing us closer to a transition away from fossil fuel use.

Such rosy scenarios, however, tend to abstract from the realities of a “catastrophe capitalism” that is inexorably tied to the extraction and exploitation of fossil fuels, and which has deeply embedded “Big Oil” in all facets of our lives. Like all moments of sharp change, the eventual path we take out of these multiple, intersecting crises — an oil-price crash, severe economic downturn, and virus pandemic — will depend on our capacities to build effective political alternatives to “fossil capital.”

We need to pay close attention to the winners and losers that might emerge from this current moment, and be wary of equating the temporary (albeit severe) collapse of an oil-based economy with the demise of the system itself.

The Middle East, Russia, and US Oil

There is a long and complex story behind the rise of an oil-centered global capitalism. This story encompasses the displacement of coal by oil and gas in the early twenieth century, the rise of Middle East oil producers (led by Saudi Arabia) through the postwar period, numerous wars and revolutions, huge fluctuations in global oil prices in the 1970s and 1980s, and major shifts in the structure of the global oil industry.

Importantly, this history is also centrally linked to how global finance developed in the postwar period — a fact often omitted in accounts that focus too much on oil as a physical commodity. Flows of so-called petrodollars were essential to the emergence of new financial markets from the 1960s onwards, the rise of Anglo-American financial dominance, and the patterns of debt dependency that continue to mark the relationships between countries in the North and South. Oil, in short, had come to permeate all aspects of global capitalism by the end of the twenieth century.

Beginning in the early 2000s, world oil prices rose steadily on the back of the increasing global demand associated with the rise of China. Prices fell back sharply in 2008 with the global economic crisis, but soon resumed their upward trajectory and eventually peaked at around $114/barrel in mid-2014.

This was a financial boon for most Middle East oil exporters, and carried major consequences for the political dynamics of the wider Middle East region. But the extended period of rising prices also benefited marginal producers elsewhere in the world. Most significantly, investments in the development of so-called nonconventional oil and gas supplies — reserves that are difficult and significantly more expensive to extract than conventional fossil fuels — were strongly incentivized during this prolonged period of high oil prices.

Fracking Bonanza

Of particular relevance here is US shale, crude oil that is held in shale or sandstone of low permeability and which is typically extracted through fracturing the rock by pressurized liquid (hence the term “fracking”). There are a variety of ways of calculating the “break-even” cost of shale production: this figure changes depending on the particular oil field and the prevailing costs of technology, labor, taxes, and so forth, but a widely quoted figure is that most US shale producers require a price of $45/barrel or more to turn a profit. By contrast, Saudi oil has a production cost of around US$4/barrel, and Russian oil around US$10/barrel.

These comparisons need to be interpreted with care, as Saudi Arabia and Russia are states, not companies, and they depend heavily on oil and gas revenues to meet their budgetary needs — in this sense, the “break-even price” of oil for these states is much higher, and fluctuates according to levels of government spending. Nonetheless, there is no doubt that consistently high oil prices through most of the first two decades of the new millennium helped to attract large investments into shale field development and drove significant improvement in extraction technologies for these nonconventional supplies.

This, of course, was an unmitigated ecological and social disaster, which rested fundamentally on the repeated deployment of state-backed violence against indigenous populations in the United States and Canada in order to make way for pipeline routes and other infrastructure. But the result was a spectacular boom in US domestic oil production. Between 2009 and 2014, the production of US shale oil tripled, propelling the United States into the top rank of oil producers globally.

Remarkably, the United States became a net exporter of oil in early 2011, and overtook Saudi Arabia to become the world’s largest producer in 2013 — a position it has maintained until this day, and a far cry from the panicked predictions of “energy dependence” that had marked US policy debates in the early years of the new millennium.

OPEC+ and the 2020 Oil Price War

However, the huge increase in global oil inventories that resulted from this additional US production, coupled with a moderation of Chinese energy demand, a sputtering global economy, and the move toward greater use of renewable energy sources, brought the period of high global oil prices to an abrupt end in mid-2014. The price of Brent Crude, the international benchmark, fell by 70 percent through 2015, eventually bottoming out at around $30/barrel in early 2016.

This was the largest drop in oil prices in three decades. With the United States experiencing its first decline in annual oil production since 2008, many smaller and highly leveraged companies went under — for 2015, the US Energy Information Administration (EIA) estimated that the combined losses of major publicly traded onshore producers reached a staggering $67 billion.

US oil producers were not the only ones hit by the price rout of 2014–16. All major oil exporters confronted mounting budget deficits and hemorrhaging of their reserves: this included Saudi Arabia, which burned through more than one-third of its foreign reserves between the oil price peak in 2014 and end in 2016.

In the face of these mounting fiscal pressures, two of the world’s leading oil producers, Russia and Saudi Arabia, took steps to strengthen global oil prices through a series of coordinated cuts to production. They formalized this de facto alliance in a mutual pact, dubbed OPEC+, which was established between the Organization of the Petroleum Exporting Countries (OPEC) and eleven non-OPEC countries in December 2016. Until it unraveled in early March this year, OPEC+ proved successful in keeping the price of oil within a narrow band of around $50-$80.

For US oil companies, who were not bound by any of these international agreements, OPEC+ proved extremely fortuitous. In the wake of the 2015 plunge in prices, there had been a wave of consolidations and bankruptcies in the US oil industry, and the stabilization of relatively high oil prices served to reinvigorate domestic oil exploration and production. Indeed, by January 2020, daily US oil production was to reach over 12.7 million barrels, an increase of nearly 45 percent since December 2016, and up from less than 5 million barrels/day in 2008.

These figures starkly demonstrate that while most of the world’s major oil-producing countries sought to limit their production levels in line with OPEC+, US oil companies were essentially left free to increase their levels of production unhindered. As Keith Johnson noted in Foreign Policy on March 27: “No country has added more oil to the global glut in recent years than the United States — and despite the recent plunge in crude prices, US producers are still increasing output.”

Rupture

However, on March 6 this year, the OPEC+ alliance was to break apart spectacularly after Russia rejected a call by OPEC to cut global oil production by a further 1.5 million barrels/day. Not only did Russia refuse OPEC’s request, but it also announced that it would no longer abide by the initial December 2016 agreement.

The Saudis swiftly met this decision with a counterattack delivered on March 8. There was a bombshell announcement that the Kingdom was also no longer committed to the negotiated production limits: it would seek to increase its oil supply to 12.3m barrels/day in April (up from 9.7 million barrels/day in March), and then further boost its production capacity to 13 million barrels/day as soon as possible.

With the prospect of an additional several million barrels of daily supply about to hit world oil markets, the price of Brent Crude dropped more than 30 percent in the span of forty-eight hours. Global stock markets also plunged, with the Dow Jones Industrial Average falling a record 2,000 points on March 9, the largest ever intraday loss.

The precise trigger for Russia and Saudi Arabia’s decision to walk away from OPEC+ remains unclear. Some observers speculate that Russia may have been seeking to retaliate for US sanctions that had been placed on the largest Russian oil company, Rosneft, in February. Others claim that Russia’s decision needs to be understood in the context of its own internal politics, with Putin seeking to cultivate support among Russian elites closely connected to the oil industry, who have long opposed OPEC+. Some analysts have described the Russian and Saudi actions as a “game theory masterstroke,” which both countries were fully anticipating prior to the March announcements.

Regardless of the immediate conjunctural factors, the longer-term strategic motive behind the Russian and Saudi decision is clear. For several years, both countries had seen US oil producers, unhindered by any production limits, continue to gain market share at their expense. By threatening to flood the world with more oil — and here, Saudi Arabia’s actions are particularly decisive, due to its unique ability to quickly ramp up production capacity — they could ensure that the price of oil would fall significantly. Saudi Arabia and Russia would need to endure the pain of low oil prices for several years; in the meantime, high-cost US producers would be driven to the wall.

The Price War Meets COVID-19

However, in the days following this massive supply shock to global oil markets, it quickly became evident that a much larger blow to oil prices was looming as a result of COVID-19’s escalating spread outside of China. For oil producers, the tsunami of demand destruction greatly magnified the effects of the Saudi and Russian announcements, and pushed oil prices toward single-digit levels.

By March 29, the price of the US benchmark, West Texas Intermediate, had dropped by more than 60 percent since the beginning of the year, falling below $20/barrel, its lowest level in 18 years. Brent Crude dropped to just over $23/barrel, the lowest since 2002.

Importantly, these benchmark prices often don’t reflect the actual real price that a barrel of oil costs in the physical market: traders reported that some types of oil were selling for as low as $8/barrel. Amid predictions of $10/barrel, oil companies began to slash their spending on further exploration, rig construction, and capital expenditure.

In the face of these extremely low prices, oil producers have been scrambling to store their oil in the hope of making a profit when prices rise sometime in the future. The problem, however, is that storage space is highly limited, particularly on land, and there are logistical and technical costs associated with bringing oil to places where it can be safely stored away. Analysts have estimated that around three-quarters of the world’s storage capacity is already utilized, and that its limits will be reached by the end of May.

By mid-March, leading pipeline companies in the United States were worried that oil producers might attempt to use their infrastructure to store oil rather than transfer it somewhere else. They thus began insisting on a bill of final receipt before they would accept any new oil. Because it is expensive to shut down or temporarily halt oil wells, and land leases sometimes contain clauses that require continuous production, oil companies may prefer to give away their product rather than halt work: indeed, in mid-March, traders were bidding for Wyoming Asphalt Sour (used mostly to produce bitumen) at minus-19 cents per barrel. In effect, they were asking producers to pay them in return for taking the oil off their hands.

All of this creates enormous pressures across the entire oil value chain, from crude oil producers (both companies and countries), through to refining and the petrochemical industry. Firm bankruptcies and the shutting down of oil wells are almost certain in the immediate weeks, and will likely be concentrated among those producers who rely upon relatively high oil prices, (e.g., US and Canadian companies active in oil sands and shale production).

Indeed, the Dallas Federal Reserve confirmed this prognosis in its March monthly survey on oil and gas, where industry respondents commented that the prospect for the domestic fossil fuel industry had “never been bleaker” — this was “a perfect storm of disaster” and “the single worst reset in energy prices in [a] lifetime.”

Oil and Finance

But mapping the potential trajectories of this pandemic-led crash requires a closer examination of the linkages between the oil industry and the wider economy. Crucial here is the deep interconnection between energy-related companies and financial markets, most evident in the United States, where energy companies have become extremely leveraged over recent years. Much of the debt issuance by these companies — not only producers of crude oil, but also oil-field service companies, refiners, and other “mid-stream” firms such as pipeline companies — has been rated below investment grade.

Quite strikingly, energy companies have been the biggest issuers of “junk bonds” in the United States for ten out of the last eleven years, and now make up more than 11 percent of the entire US junk bond market. The problem is compounded by the very significant amount of unsecured debt (debt that is not backed by any collateral) of US energy companies: this figure surpassed the levels of secured debt for the first time in 2016, reaching $70 billion in December 2019, up from only $1 billion in 2015.

With the cratering of demand in the wake of COVID-19, amplified by the Russia/Saudi decision to increase production levels, many energy-related companies face an imminent downgrade to their financial ratings. UBS Group estimated on March 16 that up to $140 billion of bonds issued by US energy companies are at risk of becoming “fallen angels” (i.e., losing their investment-grade status).

As this debt is downgraded to junk-bond territory, the increased supply will act to lower bond prices while increasing their yields (the interest paid on the bond, which moves inversely to price in the case of bonds). One possible consequence is a liquidity crisis where energy companies not only find it very difficult to find buyers for their debt — a critical issue as many are due to renegotiate their debt throughout 2020 — but are also forced to pay much higher interest rates on their bonds.

Wave of Bankruptcies

The net result will undoubtedly be a sharp increase in bankruptcies among such US energy companies over 2020 and 2021. Indeed, the first of these casualties occurred on April 1, with the filing for Chapter 11 by Whiting Petroleum, the largest independent oil company in North Dakota, which is the second-biggest US oil-producing state.

Whiting carried more than $2.8 billion of debt on its books, but just days before the Chapter 11 filing, its senior executives had awarded themselves $14.6 million in bonuses. The company’s CEO walked away with an immediate payment of $6.4 million — much luckier than the one-third of the company’s workforce that had been fired last July.

Whiting is almost certainly the first in a coming wave of energy company bankruptcies; indeed, Rystad Energy estimated on April 3 that if oil continues to sit around $20/barrel, then more than five hundred firms would be pushed into Chapter 11 over 2020–21, the largest number of such filings in modern history.

Such defaults could seriously destabilize other parts of the financial system. Pension funds, insurance companies, banks, and other financial institutions hold large quantities of energy debt, and may be placed at risk in the event of a large wave of corporate defaults. Smaller US regional banks, in particular, are heavily exposed to the oil and gas sector.

Recent years have also seen the widespread practice of securitizing highly leveraged corporate loans — the bundling together of a large number of risky corporate loans that are then sold as securities known as collateralized loan obligations (CLOs). Although it is difficult to disaggregate CLOs by sector or to determine with any precision who holds them, a wave of defaults among oil and gas companies could cascade through financial markets in much the same way that occurred with mortgage-backed securities in 2008.

Such interdependencies with financial markets are not unique to the fossil fuel industry. However, this sector stands out particularly sharply among the potential land mines that lay littered across financial markets today. Very high levels of unsecured debt, a predominance across junk bond and distressed debt categories, and the extreme shock presented by the oil price crash — all these factors combine to make this sector a likely candidate for the propagation of severe financial stress throughout other parts of the global economy (much like the real estate sector in 2008–9).

Winners and Losers

It is certain that all parts of the fossil fuel industry will face a severe crisis over the remainder of this year and into 2021. But what might this mean for our ecological future? Unfortunately, unless fossil capital can be effectively challenged now, a wave of bankruptcies in the energy sector is actually likely to accelerate the further centralization of control by the largest oil majors.

The mega-firms collectively known as “Big Oil” — Exxon, Shell, BP, and a handful of others — are much better positioned to survive this crisis than smaller producers. They tend to be vertically integrated firms: in other words, they are active across the entire energy value chain, including refining, and thus will have some of their losses in crude production offset by the lower cost of fuel inputs for their downstream operations. As truly global firms, they have reserves and assets distributed across the world, not solely in the higher-cost shale fields of the United States. Financially, these firms also tend to have much deeper pockets, and their prospects are deeply entwined with broader financial markets (including pension funds). In the UK, for example, BP and Shell account for a remarkable one-fifth of all FTSE dividends.

This scenario is precisely the one that leading financial firms are expecting to see unfold over the next twelve to eighteen months. Goldman Sachs, for example, noted recently that while the current crisis will undoubtedly “be a game changer for the industry,” the probable outcome is that the largest firms will consolidate the best assets and shed the worst: “When the industry emerges from this downturn, there will be fewer companies of higher asset quality.”

Interindustry disputes over state support to the ailing shale industry in the United States also reflect this possible outcome. Here, as Justin Mikulka has meticulously documented, large oil majors such as Exxon have sought to hasten the collapse of smaller producers and have vigorously opposed any state support to the shale industry.

Mikulka cites the CEO of one shale firm, Pioneer Natural Resources, who told CNBC that efforts to engage the Trump administration in support of shale producers were not going well: “We’ve had opposition from Exxon who controls API [American Petroleum Institute] and the TXOGA [Texas Oil and Gas Association] . . . they prefer all the independents to go bankrupt and pick up the scraps.”

Exploiting the Crisis

For this reason, the current moment presents a real danger for climate justice campaigns. In the United States, for example, the Trump administration has agreed to loosen environmental regulations for power plants, factories, and other industrial facilities. This will essentially mean that these polluters are allowed to “self-monitor” their own pollution levels, according to a recent report in the New York Times.

The Environmental Protection Agency has rolled out this new policy as part of its plan for addressing the COVID-19 crisis. Tellingly, however, it was also one of the key demands raised by the American Petroleum Institute in a letter sent by the Big Oil lobbyists to the Trump administration on March 20. It is not just the fossil fuel industry that is attempting to use this crisis to roll back environmental regulations: large banks and financial firms are also pushing for a relaxation on climate change reporting requirements, and a delay to climate change “stress tests.”

A scenario that sees the undermining of (already inadequate) environmental regulations and a wave of industry consolidation will ultimately place Big Oil in a stronger position to capitalize on a post-viral world. While oil prices are today at historically low levels, they will not remain there over the longer term. One of the critical consequences of today’s vast destruction in the demand for oil is that most leading oil companies are announcing savage cuts to their capital expenditure (CAPEX) on oil exploration and project development.

For the oil majors, these initial cuts have averaged around 20 percent over the last few weeks. They are even higher in the shale industry, where one energy consultant expects a 40 percent drop in spending over 2020. It takes considerable time and expense to restart or bring new oil production online after projects have been halted or oil wells shut in: the effects of today’s cutbacks to CAPEX will be felt in supply constraints for some time in the future.

This creates a strong possibility of a sharp rebound in prices as we emerge from this crisis — an outcome that will incentivize a renewed wave of investment and expansion in fossil fuels globally (much as happened through the recent history of US shale production).

Global Fortunes

How might this be reflected beyond the United States and the fortunes of the large, globally diversified oil majors? Here, we also need to differentiate between the more powerful oil-producing states and other poorer oil exporters. Countries like Saudi Arabia, the United Arab Emirates, and other Gulf states will certainly experience rising deficits and greater pressure on government spending in a prolonged period of low oil prices.

These states, however, have relatively low levels of existing debt and can borrow quite cheaply on international markets. The Gulf’s particular class structure — an overwhelming reliance on temporary migrant workers that make up more than 50 percent of the region’s labor force — also means that any sharp economic contraction can be partially displaced through simply sending migrant workers home (as happened in Dubai in the aftermath of the 2008 crisis). Indeed, in a parallel to the possible strengthening of “Big Oil” through this crisis, the Gulf states could see their position further consolidated if assets in neighboring countries become more cheaply available in a post-viral world.

One important market here is India, where companies headquartered in the Gulf are continuing to make significant inroads in expectation of a boom in future energy demand. The Gulf’s strategic insertion within trade and financial networks connected to China is also important to highlight. Crude oil and petrochemicals remain central to these connections, and work on key projects in these sectors is continuing throughout the current crisis. These projects include Abu Dhabi’s Ruwais Refinery, which will be the largest integrated refinery and petrochemical plant in the world on completion.

Poorer oil exporters will face much more serious problems as a result of the current plunge in oil prices. Such countries include Ecuador, Venezuela, and Iran — the latter two are also contending with the impact of savage US-imposed sanctions. States such as Nigeria — which depends upon oil for 57 percent of government revenue, and over 90 percent of foreign-exchange earnings — will find it exceedingly difficult to meet budgetary demands. This will have deadly consequences in the midst of the pandemic. Similarly, for Iraq, where oil exports make up 90 percent of government revenues and a large part of the population depends upon the public sector for wages or pensions, it is difficult to see how the expected shortfall in funding will be addressed.

Strange Bedfellows

The problems these countries face, however, should not be blamed on low oil prices. Long-standing legacies of colonialism, the destruction wrought by Western-led wars and occupation, and the relations of debt and dependency that bind these countries to the centers of the global economy need to be placed up front in tackling this pandemic.

Nigeria, for example, may depend on oil for a large proportion of government revenues, but more than half of these revenues are spent simply on servicing existing foreign debt. Any attempt to move beyond fossil fuel dependency at the global level must challenge this combustible mix of oil, debt, and finance.

At time of writing, there is talk of a possible deal between the United States, Saudi Arabia, and Russia around oil production levels. It is unlikely that such a deal would have any sustained effect on the price of oil, given the vast destruction of demand that has occurred in recent weeks. Some observers have noted the irony of seeing leading Republicans, who had previously called for the dismantling of OPEC because of its “cartel”-like behavior, now demanding greater market collusion with Saudi Arabia and Russia over prices.

There is no doubt that the mutually reinforcing crises of the COVID-19 pandemic and the global economic downturn are provoking a whole range of unexpected political realignments, strange bedfellows, and new openings for political change. But this moment is also one where previously existing arrangements may be reworked and consolidated in the interests of the most powerful.

We face the very real danger of an emboldened and resurgent oil industry, positioned ever more centrally within our political and economic systems. That would be a disastrous outcome of the current pandemic.