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Crude reality: Oil giants split on fossil fuels’ future

On a blue-sky March day, one week after the World Health Organisation declared the pandemic, a nearly 300-metre-long tanker set sail from Chevron’s Wheatstone project on the coast of Western Australia carrying a cargo of liquefied natural gas. The gas on board had been super-chilled: first to minus 130 degrees – the point at which it flashes over to a liquid – then even further to minus 162 degrees.

Like almost all tankers leaving Australia loaded with liquefied gas, this vessel, the British Mentor, would usually have been bound for a port somewhere in North Asia – Japan, China, South Korea – where its contents would be regasified, put into pipelines and sent to customers for power generation, heating and manufacturing.

Instead, it would spend the next two weeks idling at sea, either anchored in the sparkling Indian Ocean or sailing around in circles. And finally, after finding a new buyer, it set off on a highly unusual voyage crossing the entire South Pacific to Manzanillo, Mexico, 15,000 kilometres away.

Chevron's Wheatstone LNG project.

Chevron’s Wheatstone LNG project.Credit:

Australia’s big producers of liquefied natural gas (LNG) – the nation’s second largest commodity export – have been hit hard by the coronavirus pandemic, and the story of the stranded British Mentor is far from isolated.

As lockdown restrictions wipe fuel demand and buyers delay deliveries, the number of LNG cargoes loaded in Australia last month fell from 93 to 85, according to EnergyQuest, and, of those, one in three was forced to spend extended periods idling at sea.

No one in the industry disputes the magnitude of the crisis pummelling oil and gas right now, or that the shock will be felt for years. BP and Shell responded first, radically reducing future price assumptions causing write-downs of up to $54 billion combined. In Australia, Woodside wrote off $6.3 billion, Origin $1.2 billion and Santos $1.1 billion. Oil Search slashed $500 million and axed a third of its workforce. Most producers significantly lowered their forecasts for benchmark Brent oil and LNG – which is tied to the oil price – out to 2025-26.

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On the question of what lies beyond, however, an unmistakable split in the industry is coming into focus: Once the COVID-19 smog lifts, will demand and prices for oil and gas return to pre-pandemic levels? Or will the downturn be deeper, longer-lasting, and accelerate the transition away from fossil fuels in favour of clean alternatives?

“We are seeing a really big difference narratively between companies in different regions and we’ve been observing it for a while,” says Zoe Whitton, Citi’s head of environment, social and governance research for Asia.

“But the Europeans are reading a much longer-term transition into this crisis than the Americans or the Australians.”

As crude prices tumbled below $US16 a barrel, producers such as Britain’s BP, Italy’s Eni, France’s Total and Royal Dutch Shell have been hastening preparations for a future that needs less oil and gas, renewing commitments to diversifying, sparing clean-energy investments from budget cuts and bringing forward projections for when they expect oil consumption to peak and decline.

COVID-19 has gutted demand to such an extent – and at a time when electric vehicles and renewable energy already loom as near-term threats – that BP’s Bernard Looney has openly queried whether fossil fuel usage may have peaked already.

“I would not rule that out,” he says.

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This focus in Europe, analysts explain, has much to do with the combination of greater climate pressure from investors and assertive government decarbonisation policies. Australian producers and the Morrison government – which backs a “gas-led” recovery from COVID-19 – remain trenchantly committed to expanding fossil fuels.

The idea that oil and gas demand may have peaked has been brushed off by many in the sector, who say energy demand is growing not shrinking, renewables lack scale, and the fundamentals of their business have not changed.

“I see some of those demand forecasts and to be quite honest with you I’m not sure how they’ve developed them,” Woodside chief Peter Coleman tells The Age and The Sydney Morning Herald.

“It may take some time to recover and that will be based on the travel restrictions that will be in place by host governments around COVID-19 and I can’t predict how long it will take for COVID-19 to work its way out of the system. But I think you are crystal ball-gazing if you develop a view that the world has had permanent demand destruction.”

Investors, however, are no longer as quick to dismiss the notion of peak demand. Credit Suisse’s oil and gas analyst, Saul Kavonic, says the shock of COVID-19 has made “downside scenarios more stark and more plausible”.

The possibility of peak oil, he says, “has to be considered”.

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Woodside chief Peter Coleman says in the longer term there will be a splitting of crude oil and gas pricing.

Woodside chief Peter Coleman says in the longer term there will be a splitting of crude oil and gas pricing.
Credit:Attila Csaszar

“That’s the issue with COVID, there are quite a few different scenarios that could play out here,” he says. “A prudent approach would be to consider the downside scenarios, and the downside scenario that we have already seen peak oil, to ensure the investment decisions you make are still resilient to those scenarios.”

Peaking demand will not trigger a sharp consumption decline. Even low-case forecasts say the world needs another trillion barrels of oil in the next 30 years. “There’ll be robust oil and gas demand for decades,” says Kavonic. It will just become a declining industry. “Exactly where that demand peaks and the pace at which it declines is a debatable question.”

The chief concern now, he adds, is the danger of oversupply if LNG producers invest in new projects based on overly optimistic demand forecasts.

I think you are crystal ball-gazing if you develop a view that the world has had permanent demand destruction.

Peter Coleman, Woodside CEO

Aside from Origin, most Australian producers are “pure-play”, meaning they are solely in oil and gas. While large European counterparts are blazing into wind and solar power, Santos and Woodside’s diversification strategies rest in emerging gas-related technologies such as hydrogen. Woodside recently noted renewables were unable to generate adequate returns.

Australians, however, produce more gas than oil, so are not as vulnerable to the most undeniable transition threats. Transport electrification will erode oil demand, but some trends are powerfully in LNG’s favour. Its usage in industrial heat, for example, lacks viable alternatives. Industry chiefs also believe that because gas is less-polluting than coal and less-intermittent than renewables, LNG will be what bridges the gap.

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Oil tankers are seen anchored in the Pacific Ocean carrying crude oil no one will buy.

Oil tankers are seen anchored in the Pacific Ocean carrying crude oil no one will buy.Credit:Patrick T. Fallon/Bloomberg

“We believe in the longer term there will be a splitting of crude oil and gas pricing as gas becomes more and more into demand as people see that it becomes a necessary – not an optional, but necessary – part of the transition to a lower-carbon world,” Woodside’s Coleman says.

However, gas’s future as a “transition fuel” is no longer the sure thing it once was, owing to increasing scientific concerns around emissions in drilling and shipping, and ever-growing advances in renewable technology.

“Investors have really struggled with the phrase ‘gas is a transition fuel’ for a number of years now … that’s no longer a strategy in and of itself,” says Julien Vincent of shareholder activist Market Forces. “The claims by fossil fuel companies that their futures are secure no matter what has been disproven.”

Citi’s Whitton agrees that gas’s future under all scenarios aligned with Paris climate goals is far less certain, but says the “swing factor” for Australian producers is exposure to Asia, where decarbonisation policies guiding energy investment could go either way.

Will they or won’t they continue increasing gas in their energy mix?

“When you are a pure-play producer, it is difficult to change, yet you are more exposed rather than less exposed and there is a danger that you’ll interpret the energy-system change as a choice you make rather than a choice the rest of the world makes,” Whitton says. “I suspect there’s a bit of that happening.”

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