Bounce back in China’s manufacturing sector points the way; other countries expected to follow as lockdown is lifted
Latest in series of on-line ADIPEC Energy Dialogues hears it could be late 2021 before oil and gas markets recover to 2019 volumes
OPEC+ supply constraints coming under pressure from US shale and indebted oil producers as prices strengthen; production cuts likely to be rolled over and extended
Abu Dhabi, UAE – XX June, 2020 – A revival in manufacturing across the world holds the key to the mid-term recovery of oil and gas markets, with consumer demand likely to lag as the energy industry begins to recover from the twin shock of the COVID-19 crisis and the resulting demand crash.
Participating in the latest online ADIPEC Energy Dialogue, Rachel Ziemba, an economic and political risk expert and Founder of Ziemba Insights, said the early signs from China, the first major economy to exit from the COVID-19 induced lockdown, are that manufacturing has bounced back more than consumption and that trend could be repeated in other countries.
“It is notable that the COVID crisis and the associated economic and energy crisis has really been the first to blow out the global consumer,” Ziemba said. “2008 was much more of a hit to the financial sector and manufacturing. This time it is the reverse. The big question is how quickly consumer demand will come back.”
Ziemba added it could be well into 2021 before oil and gas markets get to volumes approaching where the industry was at the end of 2019.
Looking at the trends likely to impact the recovery of oil markets in the mid-term, Ziemba said the OPEC Plus group of producers has had some success in tightening the market. But a question mark hangs over how long supply can be constrained.
“The challenge is that a few countries, those that are most economically strapped and not eligible for debt relief, are not complying in full and some have barely reduced production,” Ziemba said. “Despite pressure from the likes of Saudi Arabia and Russia, it is going to be very difficult for them to comply because these are countries that had big fiscal deficits when oil was $70 a barrel.
“The other challenge is that we are starting to see parts of the US shale industry starting to reverse shut ins. We are also seeing more rig activity after many weeks of decline. In a price range of mid-30s into a 40 range, there will be more entities that can make some money and the risk is that it puts even more pressure on OPEC Plus. So, I do think the most likely scenario is a rolling over and extension of the supply cuts.”
Access to credit, to support economic recovery, is an additional challenge for indebted oil producing countries, which are having to deal with multiple shocks at the same time, including sizable outbreaks of the COVID-19 coronavirus that may or may not be under control. Many of the oil producers that are in a tougher financial position than their rich peers are too wealthy to qualify for debt relief, Ziemba said, heightening social, political and economic risks which could further impact the oil and gas industry.
Elsewhere, as oil and gas companies seek for ways to recover, Ziemba said she expects to see some industry consolidation, particularly in the United States with more cash rich entities looking to go into smaller, more speculative areas that are lower cost. She also highlighted the possibility of further job cuts as companies become leaner and decide between boosting commercial reserves, or partnering with governments. Meanwhile, she added she expects to see more National Oil Company enter into partnerships, for example Middle East producers and Asian buyers, which enable greater creativity in payment terms and contracts.
The ADIPEC Energy Dialogue is a series of weekly online thought leadership events created by dmg events, organisers of the annual Abu Dhabi International Exhibition and Conference. Featuring key stakeholders and decision-makers in the oil and gas industry, the dialogues focus on how the industry is evolving and transforming in response to the rapidly changing energy market.
ADIPEC 2020 is projected to attract more than 155,000 energy professionals from 67 countries; including senior decision-makers and energy industry thought leaders, over 2,200 exhibiting companies and 23 national exhibiting pavilions as oil and gas companies convene to share views and best practices to address the long-term impact of the triple challenge of lower oil prices, weaker demand and over supply.
Held under the patronage of His Highness Sheikh Khalifa Bin Zayed Al Nahyan, President of the UAE; hosted by the Abu Dhabi National Oil Company (ADNOC); and supported by the UAE Ministry of Energy & Industry, the Abu Dhabi Chamber, and the Abu Dhabi Tourism and Culture Authority, ADIPEC is scheduled to take place from November 9 to 11, at the Abu Dhabi National Exhibition Centre (ADNEC).
To watch the Energy Dialogue series go to: https://www.youtube.com/channel/UCnFtPtFwMrRkuGUTk4Rh4tA
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International expansions for Saudi Aramco – the largest oil company in the world – are not uncommon. But up to this point, those expansions have followed a certain logic: to create entrenched demand for Saudi crude in the world’s largest consuming markets. But Saudi champion’s latest expansion move defies, or perhaps, changes that logic, as Aramco returns to Europe. And not just any part of Europe, but Eastern Europe – an area of the world dominated by Russia – as Saudi Aramco acquires downstream assets from Poland’s PKN Orlen and signs quite a significant crude supply deal. How is this important? Let us examine.
First, the deal itself and its history. As part of the current Polish government’s plan to strengthen its national ‘crown jewels’ in line with its more nationalistic stance, state energy firm PKN Orlen announced plans to purchase its fellow Polish rival (and also state-owned) Grupa Lotos. The outright purchase fell afoul of EU anti-competition rules, which meant that PKN Orlen had to divest some Lotos assets in order to win approval of the deal. Some of the Lotos assets – including 417 fuel stations – are being sold to Hungary’s MOL, which will also sign a long-term fuel supply agreement with PKN Orlen for the newly-acquired sites, while PKN Orlen will gain fuel retail assets in Hungary and Slovakia as part of the deal. But, more interestingly, PKN Orlen has chosen to sell a 30% stake in the Lotos Gdansk refinery in Poland (with a crude processing capacity of 210,000 bd) to Saudi Aramco, alongside a stake in a fuel logistic subsidiary and jet fuel joint venture supply arrangement between Lotos and BP. In return, PKN Orlen will also sign a long-term contract to purchase between 200,000-337,000 b/d of crude from Aramco, which is an addition to the current contract for 100,000 b/d of Saudi crude that already exists. At a maximum, that figure will cover more than half of Poland’s crude oil requirements, but PKN Orlen has also said that it plans to direct some of that new supply to several of its other refineries elsewhere in Lithuania and the Czech Republic.
For Saudi Aramco, this is very interesting. While Aramco has always been a presence in Europe as a major crude supplier, its expansion plans over the past decade have been focused elsewhere. In the US, where it acquired full ownership of the Motiva joint venture from Shell in 2017. In doing so, it acquired control of Port Arthur, the largest refinery in North America, and has been on a petrochemicals-focused expansion since. In Asia, where Aramco has been busy creating significant nodes for its crude – in China, in India and in Malaysia (to serve the Southeast Asia and facilitate trade). And at home, where the focus has on expanding refining and petrochemical capacity, and strengthen its natural gas position. So this expansion in Europe – a mature market with a low ceiling for growth, even in Eastern Europe, is interesting. Why Poland, and not East or southern Africa? The answer seems fairly obvious: Russia.
The current era of relatively peaceful cooperation between Saudi Arabia and Russia in the oil sphere is recent. Very recent. It was not too long ago that Saudi Arabia and Russia were locked in a crude price war, which had devastating consequences, and ultimately led to the détente through OPEC+ that presaged an unprecedented supply control deal. That was through necessity, as the world faced the far ranging impact of the Covid-19 pandemic. But remove that lens of cooperation, and Saudi Arabia and Russia are actual rivals. With the current supply easing strategy through OPEC+ gradually coming to an end, this could remove the need for the that club (by say 2H 2022). And with Russia not being part of OPEC itself – where Saudi Arabia is the kingpin – cooperation is no longer necessary once the world returns to normality.
So the Polish deal is canny. In a statement, Aramco stated that ‘the investments will widen (our) presence in the European downstream sector and further expand (our) crude imports into Poland, which aligns with PKN Orlen’s strategy of diversifying its energy supplies’. Which hints at the other geopolitical aspect in play. Europe’s major reliance on Russia for its crude and natural gas has been a minefield – see the recent price chaos in the European natural gas markets – and countries that were formally under the Soviet sphere of influence have been trying to wean themselves off reliance from a politically unpredictable neighbour. Poland’s current disillusion with EU membership (at least from the ruling party) are well-documented, but its entanglement with Russia is existential. The Cold War is not more than 30 years gone.
For Saudi Aramco, the move aligns with its desire to optimise export sales from its Red Sea-facing terminals Yanbu, Jeddah, Shuqaiq and Rabigh, which have closer access to Europe through the Suez Canal. It is for the same reason that Aramco’s trading subsidiary ATC recently signed a deal with German refiner/trader Klesch Group for a 3-year supply of 110,000 b/d crude. It would seem that Saudi Arabia is anticipating an eventual end to the OPEC+ era of cooperative and a return to rivalry. And in a rivalry, that means having to make power moves. The PKN Orlen deal is a power move, since it brings Aramco squarely in Russia’s backyard, directly displacing Russian market share. Not just in Poland, but in other markets as well. And with a geopolitical situation that is fragile – see the recent tensions about Russian military build-up at the Ukrainian borders – that plays into Aramco’s hands. European sales make up only a fraction of the daily flotilla of Saudi crude to enters international markets, but even though European consumption is in structural decline, there are still volumes required.
How will Russia react? Politically, it is on the backfoot, but its entrenched positions in Europe allows it to hold plenty of sway. European reservations about the Putin administration and climate change goals do not detract from commercial reality that Europe needs energy now. The debate of the Nord Stream 2 pipeline is proof of that. Russian crude freed up from being directed to Eastern Europe means a surplus to sell elsewhere. Which means that Russia will be looking at deals with other countries and refiners, possibly in markets with Aramco is dominant. That level of tension won’t be seen for a while – these deals takes months and years to complete – but we can certainly expect that agitation to be reflected in upcoming OPEC+ discussions. The club recently endorsed another expected 400,000 b/d of supply easing for January. Reading the tea leaves – of which the PKN Orlen is one – makes it sound like there will not be much more cooperation beyond April, once the supply deal is anticipated to end.
End of Article
- Crude price trading range: Brent – US$86-88/b, WTI – US$84-86/b
- Crude oil benchmarks globally continue their gain streak for a fifth week, as the market bounces back from the lows seen in early December as the threat of the Omicron virus variant fades and signs point to tightening balances on strong consumption
- This could set the stage for US$100/b oil by midyear – as predicted by several key analysts – as consumption rebounds ahead of summer travel and OPEC+ remains locked into its gradual consumption easing schedule
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