Oil prices rose to their highest level in five months in the last week of August as production cuts by the OPEC+ alliance helped balance a market in recovery from the demand shock caused by the coronavirus pandemic. Hurricane activity that forced the shutdown of more than 80% of oil production in the Gulf of Mexico on August 25-26 was another factor behind the rally. But the underlying trend remains bearish with demand likely to remain anemic amid uncertainty over the future course of the pandemic and possible new risks to the global economy.

In its latest Monthly Oil Market Report, OPEC revised its 2020 demand forecast, citing a weaker economic growth forecast by the International Monetary Fund. OPEC now sees oil demand growth down by 100,000 barrels per day in August compared with its July estimate. Total demand for 2020 is expected to fall by 9.09 million barrels per day (mb/d) to 90.63 mb/d compared with a pre-crisis forecast of 101 mb/d for this year.

Even with a recovery in demand from April lows, particularly in China, where the economy rebounded in the second quarter, the 2020 outlook leaves demand short of the 2019 level when consumption was estimated at close to 100 mb/d. Limited air and land mobility due to the lingering threat of the coronavirus in large parts of the world, the switch to more digital business practices, and a focus on green recovery packages by governments may lead to embedded structural changes in the energy market. This has led some analysts to predict that demand has already peaked and may never return to pre-pandemic levels.

This theory appears to be borne out by OPEC’s calculations. In 2019, it anticipated that demand by 2030 would be 10 mb/d below its 2007 estimates of 118 mb/d. Further revisions are now likely as the previous forecast did not account for the disruptive influence of the global health crisis.

The dual shock of a demand slump as the pandemic took hold earlier in the year, and a supply glut caused by a battle for market share between OPEC giant Saudi Arabia and erstwhile competitor Russia, pushed oil prices to historic lows and U.S. prices briefly traded in negative territory. The scale of the demand destruction and the threat to the economies of the hydrocarbon reliant economies of OPEC member states forced a reckoning and a return to the negotiating table by the 24 parties to the Declaration of Cooperation, which had come together in early 2016 to manage a previous oil price shock.

The G-20 group of industrialized countries – with Saudi Arabia holding the 2020 presidency – managed to strike an agreement with the Russian-led non-OPEC group of producers to slash production by close to 10 mb/d. In addition, the United States, Canada, and others agreed to support the deal with voluntary output cuts. However, some cuts, as was the case with U.S. shale oil production and Canadian oil sands, were involuntary as the oil price slump made production uneconomic. The result of the cuts, which at one point totaled close to 15 mb/d, was a gradual improvement in oil prices, which have rebounded in a highly volatile market. By OPEC’s calculations in late July, global benchmark Brent blend crude oil futures had recovered by around $24 per barrel of oil (/bbl) from April lows, and U.S. marker crude West Texas Intermediate was up by $78/bbl. Since then, prices have moved slightly higher as the OPEC+ cuts absorbed the overhang and allowed for a narrowing of the contango between the front-month contract and forward months, indicating a tighter market. This allowed OPEC+ to scale back some of the cuts and increase production for August to December, although some OPEC ministers have urged caution given the unpredictable nature of the pandemic and the possibility of a slower than anticipated reopening of major economies.

If anything, the experience of 2020 sharpened minds to the extent that OPEC and its allies agreed on a series of tapered production cuts to take them to 2022. Saudi Energy Minister Prince Abdulaziz bin Salman, speaking during a virtual meeting of the Joint Ministerial Monitoring Committee that monitors markets and compliance with the OPEC+ accord, did not exclude output restrictions lasting beyond 2022. OPEC+ members should not relax their efforts, he said, “because the endeavor will be with us until April 2022 and maybe more.”

One of the big unknowns is whether the current crisis will accelerate the transition to a lower-carbon economy or whether relatively weak oil and gas prices will keep them competitive with lower-cost renewable alternatives like solar and wind. There is no doubt the energy transition has been underway for some time. There is no rolling back the march toward zero or net carbon emission economic systems, a policy that the European Union has led and reinforced during the pandemic. The main question is whether the estimated $13 trillion to $20 trillion set to flow into the global economy this year and the next will prioritize green and clean energy as part of a recovery or whether more funds will be directed to health, infrastructure, digitalization, and other priority sectors to improve resilience to future shocks.

Amid this uncertainty, there appears to be some convergence of views on the need for decarbonization by oil-producing countries and oil and gas companies, many of which have put in place net-zero carbon targets to 2050, if not before. Saudi Aramco, the world’s biggest oil exporter, has joined 12 other oil companies, public and private, in the Oil and Gas Climate Initiative, a CEO-led consortium that accounts for 30% of global operated oil and gas production. Its aim is to accelerate the industry response to climate change by reducing emissions across the oil and gas industry. This includes reducing emissions of carbon dioxide and methane at source, cutting flaring, and incorporating renewable energy in the production of clean energy vectors like hydrogen. Once the oil leaves the refinery, it becomes harder to decarbonize since there are few alternatives to fossil fuels for aviation, heavy vehicle transportation, and shipping. Electric vehicles and tighter fuel efficiency standards are slowly biting into gasoline’s market share, but that is only part of the barrel. According to Ahmad Khowaiter, Saudi Aramco’s chief technology officer, up to 15% of emissions from the use of oil products can be saved upfront. “We are going to be here for a long time using oil. Best low hanging fruit is getting the carbon footprint as low as it can go,” he said in a webinar interview hosted by CERAWeek on July 30. He said transportation, both heavy and light, accounts for 57% of oil use.

Carbon capture utilization and storage is one way of trapping carbon emissions either for use in enhanced oil recovery or to produce products that lock in the carbon, but that comes at a cost. Khowaiter, an advocate of the circular carbon economy, believes the technology needs support from governments because commercial entities cannot absorb the cost on their own. The captured carbon needs to be priced into products to be commercially viable, he added.

The slow realization that fossil fuel producers will have to clean up their act to survive has led to another debate on a subject previously avoided by the major oil-producing states. Indeed, the prospect of stranded assets has again reared its head as a possible side effect of the current crisis.

A July 2020 analysis by the Doha-based Abdullah Bin Hamad Al-Attiyah International Foundation for Energy and Sustainable Development explores the risk of stranded oil, gas, and coal assets. Stranded assets refer to fossil fuel reserves that cannot be produced because of climate change policies and competition from nonfossil technologies. The report looks into how major oil and gas producers can monetize these assets faster and why major resource holders should take the risk of stranded assets seriously. The fossil fuel industry faces the possibility of stricter environmental policies that may include outright bans on the use of hydrocarbons, carbon taxes, caps, or policies that improve the competitiveness of nonfossil fueled technologies, such as electric vehicles, the report posits.

But there is a dilemma, particularly now that some major oil and gas companies are scaling back spending on oil and gas exploration. There is a need to invest in new capacity to make up for natural decline rates, which roughly average around 8% for oil and 6% for gas, annually.

As international oil companies grow increasingly averse to committing funds to long cycle oil and gas projects and are instead investing more in short-cycle projects as well as renewable energy and other low- or zero-carbon technologies and electrification, the onus will fall increasingly on Saudi Aramco, the United Arab Emirates’ Abu Dhabi National Oil Company, and other state-owned integrated oil and gas companies to pick up the slack. But with an uncertain demand outlook and the prospect of stranded assets rearing its head, there is little incentive to do so, particularly at a time when many Gulf producers are trying to diversify their economies away from overreliance on oil and gas revenue. However, they do have the advantage of lower-cost production, while higher-cost producers, such as those involved in deep offshore projects, may be the first to plug their wells.

While this is one mitigating factor, the national oil companies still have to take proactive measures to prolong the life of what, in many instances, is their largest revenue earning resource. “Most value in current production accrues in the first few years, and most reserves are held by governments and national oil companies. Therefore ‘stranded assets’ are a problem more for major resource-holding countries than for international oil companies with strategic options and relatively short reserve lives,” the Attiyah Foundation report argues.

The report recommends that major oil and gas producers consider policies for faster monetization of their assets, either by increasing production at lower prices, or through sales and privatization to ensure that “lower-cost reserves are more fully produced and that limited carbon space is not taken up by coal or higher-cost oil and gas.”

In a global energy market, it is difficult to isolate policies by geography. Carbon intensity could affect stranded assets in two ways. Some countries, such as those in the European Union, are moving to ban oil and gas with a higher carbon footprint than set benchmarks. This would mean that high-carbon assets, which may include oil and gas fields and some coal-fired power plants inside the EU, would not be able to operate while others outside would have to find a new market, the report says. It cites Algeria, which supplies pipeline gas to Europe, as an example. Russia, as the leading supplier of gas to the European market, would also be affected. Other countries may impose higher carbon taxes, which would add to production costs.

For now, OPEC and its allies seem more concerned with defending price rather than their dwindling share of the global market. But post-crisis recovery scenarios cannot ignore the warning signals that were flashing amber even before they were amplified by the pandemic. It may be difficult to see through the dark prism of the coronavirus, but the option to rewind to the pre-crisis model of rising oil demand is quickly disappearing. According to Christiana Figueres, who was instrumental in the successful negotiation that led to the Paris Agreement on climate change, there is a need to decouple greenhouse gas emissions from gross domestic product as Europe has done and tackle the economic, health, and climate challenges as a package – not in isolation – as the world emerges from the crisis.