Q&A: 2020 to leave permanent scars on energy

The oil and gas business is adept at managing change, but the Covid-19 pandemic has stretched the definition of 'challenging.' BP's chief US economist Michael Cohen discussed with Argus how 2020 may permanently change energy. Edited highlights follow.

There is a tendency in business to call the current situation "unprecedented." But history repeats itself, and often we are just at an inflection point of another cycle. Which do you think 2020 is?

It is a bit of both. Because we are all sharing it globally, it does represent an inflection point for the energy system on a couple levels. First, we see a structural break in the way in which energy is being used from the perspective of a behavioral change, in how we may be willing to use mobility to do the work that we have done in the past.

At the same time this is a health crisis that is in the process of being solved, and there are permanent scars from it on the economy. How long lasting those scars are is a key question that all of us in the energy industry are grappling with.

The third component is the government response to this health crisis. There is a distinct choice in all economies with respect to how to respond to facilitate economic growth and the extent to which "greening" — or more clean — responses are built into that thought process. Given what we have lived through with this pandemic there is a certain amount of societal demand now for fewer cars on the streets, cleaner air, less congestion, a greater appreciation for rural versus urban space. Society is going to demand that governments provide that in one way or another.

Certain governments will respond differently to that. European governments seem to be heading in one very clear direction to "build back better." The Biden administration has signaled that it also plans to take that into account. But those are exceptions to the rule, because in the broader experience of many other countries the priority is going to be getting people back into jobs and the economy running again.

Do we know how permanent those scars are, how much of 2020's drop in demand is true demand destruction?

We are going to go through phases. When [BP] looked at our energy outlook, which goes to 2050, the first phase up through 2025 is that the behavioral effects [of the pandemic], like an aversion of public transit, are going to remain with us and could lead to higher use of gasoline. And the petrochemical use for packaging and sanitation, those types of things could offset the decline in demand from the increased propensity to work from home and the decline in business travel. The balance may indeed come out where there is a higher oil demand in the near term, because the more permanent behavioral changes are not sufficient to outweigh these sort of temporary bounce-back effects.

As we start to look out beyond the 2021-22 time frame, the outlook for oil demand starts to be dominated even more by the permanent behavioral changes and overcomes the temporary effect of wanting to revert as quickly as possible to our prior habits. So the question is when does that happen and how permanent, if at all, will those things like the aversion to public transit be?

The IEA recently came out with its world energy outlook , and their view through 2030 is that those two effects sort of even out: People are not able to buy the more fuel-efficient car, and so therefore the capital stock is not turning over as much. And while we [at BP] take that into account, we are still looking at the balance of forces out through 2050. And it Is clear that those structural, more permanent effects are going to have a bigger role to play when we are looking out across that length of time.

Is the decline in business travel, and its impact on jet supply and the refining industry, one of these permanent effects?

The decline in jet has also been permanently affected. And so refineries have had to rationalize, and we have seen some permanent closures. Ultimately over the longer term in a world where demand growth is plateauing — or as we see it in two of our scenarios between 2020, 2030 and 2040 falling pretty precipitously — is there a need for incremental investments in refining capacity and [crude distillation unit] capacity over the next five years, if that is the world that we are looking at, if there has been a true structural break?

If you look back at the history of oil products, the industry has been adept at rationalizing and figuring out how to deal with uncertainty because of policies and regulations. We have lived through most recently the IMO [low sulphur marine fuel] change, further back the ultra low sulphur diesel move, and just many, many different specifications changes over the last decade. So you could argue that they will be just as adept at dealing with the loss of a significant amount of gasoline and jet fuel demand. But it is possibly a very large chunk of oil demand that that could go away.

With all these mixed signals, how are companies making investment decisions, whether to continue with short-cycle, lower cost projects, or aim for the large, long-life projects?

From a macro perspective, the real question comes down to whether the decline rate from supply with no new investment is steeper, or less than the expected decline in demand in some of the scenarios. If demand is falling more quickly than supply with no new investments, then it is clear you should not be investing in new oil supply.

But the result of our macro analysis says the opposite — that there are very few demand scenarios that we can think of before 2040 where those lines cross. Therefore, it is essential that [the industry continues] continue to spend the roughly $9 trillion-$12 trillion, or $250bn-$350bn or so per year in new oil supply in order to close that gap, even in our are rapidly declining oil demand scenario. If your demand is declining by 1-2pc per year, but supply with no new investments is declining by 5-10pc per year, then it is clear that you still need to be investing in oil and gas.

So under-investment in upstream is a legitimate concern?

Right. The short cycle in the last three years has been synonymous with the tight oil industry, but in reality it is a far broader portfolio of assets that satisfy that definition. You can have a tie-back, you can have a new drilling program — look at what happened with the Johan Sverdrup project, which went from inception to first oil in a very small period of time. So there is going to be an increasing focus for all producers on projects that are resilient, short cycle, low carbon — or at least have the ability to reduce carbon intensity at the wellhead.

The growing talk of the energy transition during the pandemic feels a bit like E&amp;Ps changing the subject from their dire financial outlook. How do we know the transition talk has longer legs than we have seen in the past?

It is real in a number of areas. [BP has] talked extensively about what our strategy is, specifically around electrification mobility, customers and products , how we are going to be working with regions and cities, how we are integrating natural gas and thinking of new strategies in the bioenergy area, the investments that we have already made in the Teesside Net Zero effort and other big projects.

But the key question is, what is the pace and the scale? I think it is clear we are running right now to show investors that we can make attractive returns from low carbon energy opportunities, just as much as we have been able to do that with the traditional oil and gas operations. Obviously we need to be able to walk and chew gum at the same time, because we need to ensure that we operate at the highest levels, perform well while we transform.

The real question from a macro perspective on behalf of all of these European companies that are making this shift quite quickly is, how do you balance the environmental, NGO and societal demand for companies to be doing something different and match that up with the value creation demands of investors for higher returns, particularly the traditionally high returns that an IOC like ourselves is expected to deliver?

Change is a constant in this business, but is there anything in this last year that has been particularly surprising?

Certainly there are a lot more new unknowns. You take what was Opec meeting every six months to three months, and then you introduce meetings every month. You have taken out a significant amount of investor interest in energy and the US E&amp;P landscape. And now we are all left to scratch our heads about what the level of reinvestment will be as prices start to rebound.

There is the question of, how disciplined will these companies be? It has always been a question, but I think when you combine on the supply side those two issues with the demand side question marks about the success of fiscal stimulus, the questions around permanent economic scarring, questions around structural behavioral changes, it leaves you with a pretty uncertain environment.

Michael Cohen will be one of the speakers at the Argus Crude Live virtual conference taking place Jan. 26-28, 2021. For full details of the conference program and how to register to attend, please visit https://www.argusmedia.com/en/conferences-events-listing/crude-live .

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