Blog Post by Nick Butler: The signs to watch
These are unprecedented and dramatic times for the whole of the global energy industry. To try to make sense of what is happening we are initiating a fortnightly commentary written by Nick Butler, a member of our advisory board and a regular contributor to the Financial Times.
The pandemic caused by the coronavirus is still at an early stage. We watch the daily numbers of reported cases, probably only a fraction of the actual count of those infected, and the shift of the geographic centre of the disease from Wuhan to Italy to Spain and at the time of writing to the United States. We do not know how long this will last, or whether it will spread further in the emerging economies of Asia and Africa. Nor do we know the impact on the global economy.
Knowing what you do not know is the beginning of good strategic thinking and planning. The crisis has produced a raft of forecasts and models but the answers they produce are as ever simply the product of the assumptions put in. The media inevitably highlight the extreme numbers and forget to mention the cautionary notes which honest forecasters always include.
To make sense of what is happening it is useful therefore to focus on a small number of leading indicators which are published regularly and which can be taken as reasonably reliable. None are perfect but together they begin to paint a picture of activity and the direction of change. Everyone will have their own company specific data. The following four indicators should add a level of context about what is happening across the world.
The first is industrial output in China. Wuhan was closed for much of the first quarter and activity in the rest of China was seriously reduced. The virus has not been completely beaten but on the published data the number of cases has dropped significantly. The pace of growth matters because China before the virus accounted for a quarter of total global energy demand, and a fifth of global oil trade. The pace with which output grows will depend not just on the physical health of the population but also on China’s ability to manage its mounting debt problems which affect the state and key sectors including property and construction.
The second is the extent to which the crisis reduces investment by the major players in the energy industry, public and private. The loss of revenue caused by the dramatic falls in oil and gas prices is now working through into corporate and national budgets. Borrowing is possible for some, while others are already heavily indebted. For the companies there are choices to be made between investment and dividend payments, for Governments choices between the many competing claims on whatever revenue they have. The outcome of these decisions will determine the level of production and therefore prices for years to come.
The third point to watch is the state of negotiations between the different oil and gas producers. Much of the recent downturn in prices has been due not to the coronavirus but to the conflict over market shares in a market where potential supply exceeds effective demand. That conflict isn’t new and is susceptible as in the past to at least temporary solutions. A resolution now would lift prices and valuations regardless of the pandemic. A further fall would further destabilise some of the most fragile states in the world.
Fourth, and last but not least, is the evolution of the political and public debate on climate change and the measures being proposed in Europe and by the Democrats in the United States to mitigate the risks involved and to move to a lower carbon economy. In the middle of one crisis which on the basis of precedent should pass with time, we shouldn’t forget there is another continuing unresolved challenge. With Europe’s proposed Green Deal still on the table, and with a Presidential election less than six months away it is worth considering that the impact of the pandemic could turn out to be less fundamental for the energy business than the decisions which could emerge from the climate debate over the next year.
These will be the points of focus for this blog. Comments, challenges and conflicting views are welcome. This year has surely given us the sharpest possible reminder that those who claim that they alone can predict the future are fools.