Oil Markets in the Time of COVID-19, with Amy Myers Jaffe

Notable Quotes

• How coronavirus is exacerbating the oil price war: “Oil prices have gotten about as close as they can come to falling into free fall that I've seen in a long time. We are now in the $30 [per barrel] range, slowly moving to $20, and the more that the market hears that some other place is in lockdown, whether it's Seattle or New Rochelle … All these things just trigger more and more pessimism.” (5:08)
• Impact of price drop on American consumers: “One of the great things about oil prices, and this happened in 2014, 2015, is that in America ... it's like we all get a tax break at the pump. It stimulated the US economy by giving average Americans more money in their pocketbook, because I'm spending less money on fuel for my car, and if it's a winter month, I'm spending less on my heating oil bill, and so forth. That is not going to happen this time, because people's spending habits have completely changed … It's not going to be the same kind of stimulus to the economy that it normally is, because the economy is in a downward trajectory because people are staying in place.” (9:49)
• Systemic challenges if oil prices remain low: “How long the storm lasts is going to matter. If we're talking about two months, probably most companies can weather the storm, but there will be a handful of companies that have taken on too much debt and they may not ... But if this turns out to be a prolonged financial crisis … and the oil price stays low, then I think we're going to see some much more systemic problems, especially in the United States, that probably need to be addressed now—sooner rather than later.” (28:36)

The Full Transcript

Kristin Hayes: Welcome to Resources Radio, a weekly podcast from Resources for the Future. I'm your host Kristin Hayes. My guest this week is Amy Myers Jaffe, the David M. Rubenstein senior fellow for energy and the environment, and director of the program on Energy Security and Climate Change at the Council on Foreign Relations. Amy is a leading expert on global energy policy, geopolitical risk, and energy and sustainability. Amy is joining me today to talk about what has been unfolding in world oil markets over the past week as the coronavirus, or COVID-19, continues to spread and radically impact human lives and the global economy. She's been in incredibly high demand this week and we're very grateful that she's been able to carve out time to talk to us here at Resources Radio. Stay with us.

Amy, thank you so much for joining us on Resources Radio. It's really great to have you.

Amy Myers Jaffe: It's great to be here.

Kristin Hayes: Great. I'm sure you've given this overview many times, but I do want to ask if we can start with a refresher on what exactly is happening here, as it would be great to place in context what has happened to oil prices in recent weeks. What has precipitated that? And, obviously the broad geopolitical context in which all of these changes are happening. Can I ask you just to start with an overview of the players and the decisions that they've taken to date?

Amy Myers Jaffe: Well, let's start way at the beginning. In the fall, we had a military conflict raging, sort of a proxy war between Iran and Saudi Arabia that raised the price of oil. The United States intervened; that made us a party to the process. Then we had the trade war. So that started take the steam out of the oil price, and you were starting to get to a point where analysts were just debating whether the market was going to be weaker or stronger, and there was disagreement. Then all of a sudden, this hint of a pandemic started. News started to trickle out of China. The oil market became very worried because China is the growth engine for energy all around the world. In other words, you're selling natural gas, you're selling oil, you're selling coal, if you're Australia, all commodities are held up or influenced highly by the rate of demand in China.

The idea that maybe somehow China was going to have to stop buying because they were going to have this lockdown in one province already started to spook the market. And then as it became clear that the crisis was even bigger than that, the Organization of Petroleum Exporting Countries (OPEC), which tries to use its members’ production levels by making a cut or not making a cut to try to regulate the oil price in the commodity market to something that is acceptable to all its members, they have a coalition with Russia and they decided they need to have a meeting, and they need to talk about making a further cut. They had made a cut last year, but they needed to make a further cut because of this new China event. What happened is everything started to fast forward and spin out of control.

In the context, we know they're going to have this OPEC meeting, they start putting out hints that they might cut production more than expected and then all of a sudden we now have a lockdown in Northern Italy, so that made it even harder. Then, push comes to shove, they get to their meeting and the Russians say, "We don't want to be part of an agreement anymore. We just think that we have to defend our market share, and we don't want the United States to take our market share from its exports of oil and gas, and we have to defend our market share, so we're not going to be a party to this agreement."

Kristin Hayes: Just to reiterate, the idea was that folks were going to cut production. Russia said, "Nope, we're not cutting production. That's how we're going to maintain our market share." Then suddenly, the idea of collectively cutting production had been set aside, and people were in it for themselves?

Amy Myers Jaffe: Yeah. That was the impression that traders had when they left the OPEC meeting. So the market was starting to go down, but then Saudi Arabia set its prices for the next month oil it was going to be selling, because it takes them a while to ship the oil to market. And they [tell] all their customers that they're cutting the price of oil by between $6 and $8 a barrel. It was unprecedented, and the market was not anticipating that. And of course, people say the Russians were not anticipating that, and it so spooked the market that literally I would say oil prices have gotten about as close as they can come to falling into free fall that I've seen in a long time. We are now in the $30 range, slowly moving to $20, and the more that the market hears that some other place is in lockdown, whether it's Seattle or New Rochelle, it doesn't matter where it is, if it's here in the United States, or it could be that Germany's Chancellor said that they're anticipating having a large problem in Germany, or the French announcement that they're closing schools.

All these things just trigger more and more pessimism because if you think about it, we all use so much oil in our daily life. We go to the store and we buy things that are packaged in plastic. We drive around in our cars, which run on oil. 80% of things that are shipped around the world, come on ships that use oil as their fuel. Airlines use oil-based jet fuel. As each prong of demand is disappearing in a historic way, this is unprecedented. The idea that Saudi Arabia was going to flood the market with oil, which they've done in the past—they've done it 1986 and they did it just recently in 2014, 2015—but the idea that everybody was going to be a free for all, on top of this total collapse in demand, completely freaked the market out and probably freaked out all the people participating in the price war. That's where we are today.

Kristin Hayes: Right. As many commentators have shared, but as you just articulated really well, what seems to be making this such an unusual situation is in fact the combination of the radical demand shock with these supply decisions that are somewhat unpredictable and have caught people off guard. And I guess I just wanted to clarify one thing about the Saudi Arabia course of action. It sounds like they didn't actually increase supply but they cut the cost of what they were already.

Amy Myers Jaffe: Oh, no. They also then ... Excuse me, I didn't elaborate. They also then subsequently said they were going to produce their oil flat out, which would be putting another two or three million barrels a day in the market. Also, they made it very sound very immediate because they have oil that's in storage tanks, close to market, like in Asia or in the Caribbean or in Egypt, which then goes to Europe. So they really said, "we're flooding the market and we don't care. We're having a price war. We're going to win." They’ve done that before and they've won multiple times. Again, in fact they've had a price war against the Russians back in the 80s and they won.

So the thing that's really different today is that normally, as the price of oil goes down and your listeners can, I'm sure, imagine a time when the price of gasoline became suddenly very inexpensive and somebody in their family raised their hand and said, “Hey, let's drive to the lake this weekend, or this would be a good year to go to the national parks." And you get a lot more use. People drive around more because in the end it’s not as expensive. The problem for OPEC and for Saudi Arabia and Russia and so forth, is that because of COVID-19, I don't think that people are going to travel more. I mean, having the price of gasoline go down is not going to make Americans and Europeans drive to work, because everybody who can is going to work remotely anyway because of the disease, and no one is going to go on an airplane just because the airplane rates are low.

Kristin Hayes: Well, even if they would, some of those activities are in fact increasingly being banned. Right? So, even if people wanted to take advantage of that, they can't.

Amy Myers Jaffe: So normally what happens is prices get low and eventually you get a floor on the price of oil that comes from the fact that demand starts to increase and recover from the low price. Also, one of the great things about oil prices, and this happened in 2014, 2015, is that in America, when the price of oil fell in 2015, in a way when you think about it, it's like we all get a tax break at the pump. It stimulated the US economy by giving average Americans more money in their pocketbook because I'm spending less money on fuel for my car, and if it's a winter month, I'm spending less on my heating oil bill, and so forth. That is not going to happen this time because people's spending habits have completely changed. It might help Amazon or UPS that are delivering us things because we didn't want to go to the store, but it's not going to be the same kind of stimulus to the economy that it normally is because the economy is in a downward trajectory because people are staying in place.

Kristin Hayes: Yeah. It strikes me too that any change in oil prices, that's this dramatic and this rapid, leads to new winners and new losers from the standard oil market that we experience, [which] is normal fluctuations. Who might those new winners or new losers be in this, at least in the current short-term situation we find ourselves. What does that new equilibrium look like?

Amy Myers Jaffe: Well, I think at this point it's very hard to predict who the winners are going to be. I mean if you're in a business that's energy-intensive for oil and you are still able to do your business, this is good news for you. I would say for companies that are doing package delivery or food delivery, this is great news because your business is on the increase and your costs are going to be falling. For the oil producers themselves, is it going to be Saudi Arabia? Is it going to be Russia? How is the US going to fare? I think it's going to be very challenging for the US producers because it looks like price levels are going to go down below what it costs to produce oil in the United States. That's going to be very challenging here in the United States and Texas and Oklahoma and so forth. Then for Saudi Arabia, which has very low cost of production, that seems like that'd be good news because they can withstand a lower price, and of course they have a lot of money put aside from years when the oil price was high. That gives them some sort of padding. The problem is: it's a big country. The government takes a strong role in the economy and their budget is really tied to oil prices.

Kristin Hayes: Right, right. My understanding is that they've been working towards diversifying their economy, but they have not gotten there before this situation showed up. Is that a fair assessment that it's still very much an oil-driven economy? Yeah.

Amy Myers Jaffe: Yes. An oil-driven economy. They were doing a great job in trying to build new businesses, coming up with ways to promote small business, really pulling together really big entertainment events and trying to push tourism as a new sector, and they were really making good headway. This pandemic really is a double whammy for them because of course, now you're not going to have this big bunch of international travelers that are really excited about going to Saudi Arabia because we're not having travel. And, because the oil price is down, their revenue from oil is going to be lower. So, they've lost some of the momentum that they had achieved. Then the flip side is, Russia of course, has also put a lot of money aside for the rainy day. But they are also an economy that's very tied to oil and gas. Russia had this even more unique problem, which is that almost all of their oil and gas is sold either in Europe or in China, the two places that are likely to be the most hard-hit by coronavirus. Russia is also under pressure. There are all kinds of other collateral damage. It turns out that Canada has some of the highest cost production in the world and they were already under pressure, even at the $60 or $50. Well, they're going to be even under even more pressure at $20 or $30.

You get into this phase where countries that are very oil-dependent on their revenue are going to ask themselves: this time around, do we need to do something different? Then you have the backdrop. I mean the irony is, and I know this is not how people are thinking about it, the winner could be us in the sense that globally, we now see all the ways we use oil and all of the things we could do to eliminate some of that use on purpose, and not in a way that's disruptive because we have to do something about climate change, and it's been very difficult. Obviously, we don't want to have anything we do cripple economies and leave people out of work and so forth. Hopefully, this pandemic will end quickly and we can all get back to work and normal life. But I think that it's taught us that millions of people in Beijing and hundreds of thousands of people, whether it's in New York or the San Francisco Bay area, we don't all have to commute on the road to the office at the same minute in the morning every day. There are some workers of course, who cannot work remotely. If you're working in a venue like a restaurant or an entertainment venue, or if you're working in a factory, there's a lot of places, or a hospital, where you have to be there in person.

But a lot of what other people do, whether it's finance, research world, and there are a lot of other fields where a lot of what we do, we could do it working remotely, or we could work remotely some days and go to the office and see people in person on other days. That staggering of choices can actually lower emissions a tremendous amount. We have the technologies now to do things differently. That's really an interesting opportunity. Now, the problem is I have to convince you again that it's safe to use public transportation. I'm going to have to convince you again that carpooling makes sense. It's hard to know whether we're going to see the positive things we could do to lower emissions or whether we're going to take us in the opposite direction where the very tools we have to lower emissions, which is to ride together, as in our mobility is going to become problematic.

Kristin Hayes: Mm-hmm (affirmative). Yeah, I think, I mean that covers a number of things that I want to ask you to say a little bit more about too, related to the permanent, or semi-permanent at least, structural changes that you can potentially see this spring. You've mentioned some of them. What will this do to emissions? Do we have an opportunity here to actually change our relationship with oil and with telecommuting and all sorts of things? Are there other ways in which you think that this could lead to potential long-term change that we actually don't go back from?

Amy Myers Jaffe: Well, I have to say: I think this is going to give a big boost to e-commerce. If you are someone who was reluctant to have your toilet paper delivered to your house on an automated program or you really felt that you need to drive to the store to get your dog food or even just, there's certain kind of clothing items that you know that you like and you really don't actually have to try them on. I think that now, people are going to be more inclined to use these services. Actually again, it can be very energy-saving because the companies have increasingly turned to using big data programs. They have a computer, it has an algorithm and it tells them what truck to put what packages in and where the driver should route, so the driver doesn't even get to pick whether he's going left or right.

The computer in his truck tells him which package deliver first, second, third, and fourth. It's all set up around the GPS program and an efficiency program. That's why they can tell you that your package is arriving at 2:10 because the computer has already determined that, unless there's some accident on the road. The interesting thing about that opportunity is: UPS in 2017 instituted this program, and they were able to eliminate a hundred million miles of vehicle travel, just by using this efficiency program. Academics have studied it and what they found was: this lowers emissions a lot compared to having everybody drive to the store separately.

Now, if we went to the step further and some incredibly ingenious, big e-retailer decided that they could do five-minute delivery, if they put all these goods on a warehouse kind of vehicle and drove it around all the time, waiting for you to hit the button and then they could give you a quick delivery, that would be very polluting and congestion-causing. That would be a bad thing. In my view, that's where the regulator comes in. We need to provide the market guidance through design of regulation. That will encourage the companies that are going to benefit from our increased interest in these services to do them in a way that's sustainable.

Kristin Hayes: Okay. I want to ask you another, to prognosticate a little bit on a few other topics as well, if that's okay. I know that no one really has a crystal ball here, but I would really love to hear your thoughts on some other forward-looking questions and one that is really burning in my mind, is how this ends. I know people have been asking that a lot in the context of the coronavirus. What are the trajectories that we're on? What are the potential ways that this could play out, and given that these two things are related, that makes it even trickier to predict. But, what do you anticipate what one or more end games could look like, and does someone essentially have to blink? Is that the situation we find ourselves in?

Amy Myers Jaffe: Well, let's put together a couple of scenarios. If history is an instructor, typically in these oil producer price wars, somebody blinks. But the other thing that can happen, which has also happened in the history of these price wars, is that a government falls from power, and the new people come in and they blink. That happened with Venezuela. You had a government that been in a long time. There was a price war battle with Saudi Arabia in 1998, when we had the Asian financial crisis. Venezuelans went to the polls, and they voted for Hugo Chavez, and he decided that he was going to make a deal within OPEC to take policies that would raise the price of oil, and at the expense of Venezuela not increasing its own production, so that that changed things virtually overnight. Now, that's one scenario: someone blinks, or they all blink at once. They all agree to blink because the pain is just too great.

A second scenario, which is a possible scenario, is that if the coronavirus is very long-lasting, which let's hope it is not, then you might have a scenario where countries actually fail and therefore their oil production gets cut off through that failure. I just mentioned a minute ago: Venezuela. The end of the Venezuela story is that Hugo Chavez ran Venezuela in a way that deteriorated their bureaucratic efficiency in their oil sector. Things got worse and worse. Then, he died and a new leader came in, President Maduro, and he made even worse decisions. Then sanctions were put on Venezuela. The bottom line is: Venezuela's oil industry—through violence, disuse, bureaucratic neglect, bad management, where they damaged their own facilities by running them improperly, looting—all of those things have basically decimated the Venezuelan oil industry.

It's not clear, depending on what happens with climate change, with technology, with other producers, it's not clear that the Venezuelans will ever get their market back. The question would become: could that happen in other places? We have a civil war raging in Libya. Their oil industry has been suffering greatly from that civil war. So, to the extent that you have great unrest in a place because of these very low oil prices or the pandemic or both, you could see some additional oil industry facilities get damaged, and that might be the way that the market bottoms out.

Kristin Hayes: So, essentially those pieces of the oil supply would go offline and therefore they would start to rebalance supply and demand in a different way than would be optimal of course. But it would take that supply out of the market. Am I interpreting that right?

Amy Myers Jaffe: That is correct. That is the point.

Kristin Hayes: Okay.

Amy Myers Jaffe: Then, a third scenario is that the price goes down so low that the number of companies that can make money in oil goes down. The very interesting thing because people have been saying, "Well geez, if the price of oil goes very low, then companies like Shell and BP that have announced that they're shifting money into renewable energy, they're going to stop and the price of oil will be low. That's going to be too competitive with renewables and renewable investment will stop.” But I'm not sure that's the way it's going to go because all these things that we're doing now as a result of the pandemic—talking remotely, using more electronic devices, and using more electronic transmission technologies for files and Internet and doing our meetings by video conference and so forth—all of those things require a lot of electricity.

If we're all working from our houses at home, that's probably less efficient with electricity than having us all be in an office building that has more efficiency construction for its electricity use. The bottom line is: if electricity use goes up, and oil demand goes down, that could be good for renewables because there might be more market for renewables because people always forget. They think that every energy source is the same. But really, truly, oil is mainly used for transportation and industry, and electricity and renewables are used for household and other uses, some industry, and other kinds of uses. So, if the part of the economy that uses electricity is stable or increasing and the part of the economy that uses oil is unstable and decreasing, that could actually help renewables.

Kristin Hayes: Yeah, I think, as you've just articulated, there are many ways in which this could play out. But I think one thing that feels somewhat inevitable is that there are some producers who will not weather this as well as others. I guess, just one last crystal ball question to ask you is: do you see a number of producers going out of business, and specifically where? I'd love to reflect a little bit more on how you see this fairing for US producers as well. Then, my final piece of that question is: if you do envision bankruptcies in the oil patch across the world, does that pose a systemic risk to financial markets, for example, in ways that might be novel, given where we are now as well?

Amy Myers Jaffe: Well let's start with the US and then we'll move globally. The situation of the shale companies—the exploration or production companies in the United States—is very, very gated. Some companies chose, when prices were higher during the conflicts in the Middle East to lock in the price of oil using futures markets and they, therefore, are getting a higher price than whatever the price goes to. Some of them might've been very lucky and they might've locked in even $70 or $80 or $65, so those companies will have less difficulty than those that did not hedge. That's what we call it: hedging. Then you have other companies that had a high; they borrowed a lot of money to do their drilling. And then you have other companies that are cash-rich and they were able to fund their own activities through their business. Again, that's going to make a big difference between how they weather the storm or not.

Of course, how long the storm lasts is going to matter. If we're talking about two months, probably most companies can weather the storm, but there will be a handful of companies that have taken on too much debt and they may not weather the storm. But, if this turns out to be a prolonged financial crisis, and it doesn't have to mean that the pandemic itself is prolonged, but just the effect of the pandemic is prolonged, and the oil price stays low, then I think we're going to see some much more systemic problems, especially in the United States that probably need to be addressed now, sooner rather than later. That is because we have a corporate bond market in the United States and one segment of it is called the high yield bond. What does that mean? That means that a company gives me a higher payment because there's more risk involved, right?

There's a risk the company might go bankrupt, or there's a risk that they won't meet their cashflow target. So there's some class of investors who invest in those markets because they want the higher return and they're willing to absorb the risk. Maybe they hedge it and offset it with other investments. The problem is: a high percentage of the offerings in the high yield bond market are from the shale companies, and some of that paper is going to come due in 2020. A lot of it's going to come due in 2021 and we're talking about, in the billions. We're not talking about a couple of 100 million dollars. In 2014, 2015, that market almost collapsed the whole market. It was a very dicey thing. The banks let people roll over. There were some bankruptcies. But there was some rollover of debt and extended expiration dates to try to ameliorate a big failure in the market.

But now this time, it's going to probably going to take federal intervention. Maybe there's going to have to be some kind of special targeted lending facility, where Treasury or the Fed take on some of this high yield debt from the energy industry, for a period of time, and stabilize that market. Because we know from past experience, and people like me have studied it, that there's a contagion effect between the high yield bond market, the bond market, and other financial credit markets. So we can't just leave it to fester and take the position that why should we bail out these foolish companies that bet on the price of oil being high because, and I understand and agree with that sentiment, but we might not be able to afford to do that because of the systemic risk. Now if you add to that sovereign credit risks, so, who are the countries in the world that have oil? I'm sure the listeners would find this surprising that there are countries that have both high oil revenues, and they spend so much of the money, and then they borrow against the oil revenue that when the price of oil goes down, there's the possibility of a collapse in that economy. There are several countries in Africa or Latin America that could be subject to that kind of difficulty. That might make sovereign credit markets also face some systemic risks. I think it's going to be a pretty challenging outlook if it turns out the oil price is low for prolonged period of time. Of course, that's ironic because we consumers do better, the lower the price of oil is. So if the pandemic would end, and the price of gasoline would be a $1.50 at the pump by the summer, I mean everybody would be celebrating. We'd all be planning driving vacations.

It's kind of hard to predict what the effects are. But I do think that the US Fed and the Treasury Department and the Central Banks in Europe and elsewhere and IMF and so forth, have to consider carefully what the systemic risks could be and think about how we would address them if this crisis happens to look like it's going to last in a prolonged way.

Kristin Hayes: Yeah. Yeah. Well Amy, We're coming up on the end of our time to talk about this topic, but I really just want to thank you again. I know this has been a particularly crazy week for you, given the number of requests you've had for information and sharing your thoughts. Thank you again for taking the time to talk to us here on Resources Radio, and given how fluid this is and how rapidly evolving this is likely to be, we might have to get you back on in another month to reflect on what's happened since then.

Amy Myers Jaffe: I look forward to doing that, and I hope I won't have to say that my crystal ball was completely incorrect, but we can do it. If it turns out that things have completely changed in surprising ways, I would be happy to explain how that happened versus some of the things we might be expecting now.

Kristin Hayes: Great. All right, well we'll take you up on it. You've been listening to Resources Radio. Thanks for tuning in. If you have a minute, we'd really appreciate you leaving us a rating or a comment on your podcast platform of choice. Also, feel free to send us your suggestions for future episodes. Resources Radio is a podcast from Resources for the Future. RFF is an independent, nonprofit research institution in Washington DC. Our mission is to improve environmental energy and natural resource decisions through impartial economic research and policy engagement. Learn more about us at rff.org. The views expressed on this podcast are solely those of the participants. They do not necessarily represent the views of Resources for the Future, which does not take institutional positions on public policies. Resources Radio is produced by Elizabeth Wason with music by Daniel Raimi. Join us next week for another episode.