QUARANTINE KNOCK OUT

Production cuts, lay-offs, rising unemployment and debts have become the integral components of today's economic reality. According to the estimates of the International Labour Organisation (ILO), 305 million people will lose their jobs globally by July 2020, and 1.6 billion people currently employed in the informal sectors of economy will lose their livelihoods due to COVID-19. This can be explained by restrictive measures or the most affected sectors of economy they work in.

The situation became worse when the oil market began shaking in March 2020. The collapse of global oil prices and the diminishing demand for oil due to the COVID-19 pandemic were a tangible blow for the oil companies. Most of them incurred net losses in the first quarter, and those who finished the quarter with a profit indicate a significant decrease in performance compared to the last-year data. In short, some experts claim the early completion of the "oil era" in the world...

Unprofitable quarter

Almost all oil companies in the world, regardless of location, business volume or number of projects, suffered from the pandemic and the situation it caused in the oil market. For example, the shareholder net loss of the British oil and gas giant BP in 1Q2020 amounted to $4.4 billion, with the quarterly revenue fallen by 12%. The American ExxonMobil has almost the same situation: for the first time in three decades, the company completed the quarter with a loss of $610 million due to market write-offs. The Norwegian Equinor ($710 million), Italian Eni SpA (2.93 billion euros), Spanish Repsol (487 million euros) suffered huge losses too.

The data coming from of one of the main actors in the oil market, Saudi Aramco ($16.7 billion in net profit) looks somewhat optimistic though. However, this indicator is 1.3 times less compared to 2019. The company considers the decline in profits due to the dropping oil prices, a decrease in the margin of oil refining and chemicals, as well as a loss from revaluation of materials and technical resources. This was offset by changing the royalty rate for oil production from 20% to 15% as a result of falling commodity prices and rising revenues from equalizing prices for gas products, the company said. Revenue also decreased by 16%.

All these events and the ongoing uncertainty in the oil market due to low demand and prices forced oil companies to revise their investment plans for the current year towards a downward direction. Moreover, if initially the industry giants announced their intentions to reduce investment programs by 20-25%, including for new projects, a couple of months later a number of major players lowered their investment plans by 30-60% compared with the original plan.

According to the International Energy Agency (IEA), the global capital expenditures of oil companies in 2020 will decrease by about 32% compared to last year ($335 billion). OPEC expects this indicator to decrease even further - to $450 billion, although before the coronavirus pandemic, OPEC predicted that the volume of capital expenditures for exploration and production remained at the level of the previous year. These forecasts are the lowest in 13 years.

Actually, the decision of oil companies to reduce investment is the most expected one under present conditions with low oil prices. The oil industry had the same experience many years before too, but this time the situation looks completely unpredictable, which prevents companies from making long-term investment plans. “The oil price is not just low, but it is bouncing all the time. It is impossible to plan for several years ahead if the price for one week loses or adds $10 per barrel. There are no guarantees of investment return in such conditions, which is why they stop new projects,” Igor Yushkov, a leading expert at the National Energy Security Fund, a lecturer at the Financial University under the Government of the Russian Federation, said.

Most likely, the reduction in investment by oil companies will primarily affect investments in technological developments, oilfield services, and exploration. In any case, this will greatly reduce the potential for further growth in oil production in the long term. In this case, it will hit countries with economies heavily dependent on oil income.

Experts believe that cutting of investments will not have an immediate impact on global oil prices, because it will happen gradually in a few years. “A decline in investment is the first alarm signal indicating that low oil prices and a lack of balance in the market lead to worsening of financial conditions for major producers,”  Anton Pokatovich, Chief Analyst at BCS Premier, said. According to him, this creates a risk of structural problems in the long term.

Service companies under attack

Low oil prices and demand also hit the companies providing various services in the oil fields. Low prices forced oil companies to cut budgets, reduce the volume of contract orders and review service prices. Oil producers are forced to preserve wells, refuse to carry out hydraulic fracturing and planned drilling. Analysts expect the bankruptcy of most service companies while maintaining the current level of oil prices for six or more months.

The giants of the services sector, including Schlumberger, Halliburton Co., Baker Hughes Co, have already reported colossal losses in 1Q2020 and even announced lay-offs.

“Drilling services have suffered and will suffer from falling oil prices more than others in absolute terms, as it is the most expensive and capital-intensive service. The volume of orders for drilling and related oilfield services has already decreased, and this trend will continue. I assume that the overall decline in oilfield service orders due to falling oil prices will be from 30 to 50%,” the head of the Russian Drilling Company PNG said.

Denis Abakumov, managing partner of Bright consulting company, agrees with him: “Suppliers of equipment and materials will also suffer. The reduction will affect all parts of the production chain.”

Dozens of oil companies are looking forward for millions of dollars in tax benefits in the United States. According to a Bloomberg survey, 37 oil companies, service firms, and contractors have applied to the Securities and Exchange Commission for tax benefits worth more than $1.9 billion.

Oil service companies in Kazakhstan are not happy either. The Kazakh Union of Oilfield Service Companies addressed President Kasym-Zhomart Tokaev with proposals to support the industry in order to prevent a reduction in the workforce and bankruptcy of companies. Oilfield service companies have high expectations for the project to expand the Tengiz field as the only chance for earnings during the crisis. If the project is postponed until next year, which is most likely, many companies will receive less profit and, accordingly, workers will be left without the expected salary.

As for Russia, the authorities are thinking about including oil service companies in the list of backbone enterprises with annual revenues of more than 1 billion rubles. The final decision is due on June 15. Thus, the companies may get soft loans at a rate of up to 5% for replenishment of working capital, and they cannot be bankrupt, as the state monitors their financial and economic status.

The success of oilfield services companies is directly related to the plans of the producers of hydrocarbons and oil prices. So, state assistance will not resolve all the problems, and it is possible that some of the companies will have to file for bankruptcy.

Azerbaijan postpones projects

In Azerbaijan, quarantine measures and low oil prices primarily affected the implementation of new investment projects.

In particular, the COVID-19 pandemic caused delays in the construction of a new platform under the Central-Eastern Azeri (CEA) project worth $6 billion. “As part of the project, in 1Q2020, the construction of the upper modules continued at CEA’s new production platform in Bibiheybat, including the drilling module. However, due to quarantine restrictions we had to postpone the delivery of building materials and large equipment, which caused interruptions in construction,” BP-Azerbaijan reported in the quarterly report.

At the same time, the construction of the residential block of the CEA platform continues in Switzerland. There is some progress in the construction of the support block of the platform at the Heydar Aliyev Baku Deep Water Jacket Factory (BDWJF).

The company expected to complete the construction works by the middle of 2022 in order to start the production from the CEA platform in 2023. Given the strategic importance of the project for the country, we believe everything will be done to complete all construction works as planned. Indeed, CEA is the next stage in the development of the Azeri-Chirag-Guneshli block, targeting daily production at the peak up to 100K barrels of oil and 350K cubic feet of gas by drilling additional wells and installing additional offshore facilities.

Due to lower oil prices on world markets, BP and SOCAR also agreed to postpone the construction of the Mercury petrochemical complex in Turkey until 2021. Initially, it was planned to commission the plant in 2023-2025. “This project has been delayed until the first quarter of 2021, when we will consider the profitability of the project and the feasibility of investing,” Bakhtiyar Aslanbeyli, Vice President of BP, said.

Most likely, the construction of a gas processing and polymer complex planned by SOCAR in the Garadagh district of Baku will be postponed too. The current status of the project is unknown, but given the current oil prices and the global economic situation, it is hardly possible to expect its implementation in the near future.

As to exploration and development, the Norwegian Equinor announced in March the discovery of a new field in the Azerbaijani sector of the Caspian Sea. “Geological oil reserves at the field are initially estimated at more than 60 million tons, and this is enough for development economically,” the company notes.

Drilling of the first exploratory well in the shallow water of the Absheron archipelago (Shallow Water Absheron Peninsula, SWAP) was again postponed. Previously, BP, the project operator, announced its intention to begin exploration drilling in 1H2020, then postponed works until the end of this year. “We continue planning of the drilling operations for the first exploration well under the SWAP project as planned. Drilling operations will begin in early 2021 after the completion of works to optimise the drilling rig selected for these purposes,” the company said.

Otherwise, the situation in the oil and gas sector of Azerbaijan does not cause much concern, the development of the industry is stabel. However, lay-offs may occur because of the decision of SOCAR to stop oil production at high-cost onshore fields as part of Azerbaijan’s obligations under the OPEC+ deal. SOCAR assures that most of the laid off employees will be involved in the conservation of wells in onshore fields and in the maintenance of equipment.

“We don’t expect massive lay-offs. The dismissed employees will be included in the personnel reserve base. We’ll take measures for their employment at SOCAR enterprises and organisations,” SOCAR noted.

The global oil market is going through hard times. No one can accurately predict what changes the current crisis will bring in the future. It is not clear whether it will contribute to the development of green energy or increase the share of electric cars or, on the contrary, lower fuel prices will give a new impetus to the production of ICE cars. It is still quite difficult to predict the moment of balance in the market, but there is no doubt that oil demand will increase with the lifting of quarantine measures in respect of motor transport, sea and air transportation. Therefore, it’s too early to assume the end of the oil age.