IFI Op-ed #9: COVID-19 and Oil Markets’ Reaction: Policy Suggestions for Struggling Power Utilities
Benedetta Bonometti and Ali Ahmad | Monday, March 23, 2020
Amid the coronavirus pandemic, oil prices have drastically plunged to their four-year lows. However, since the current slump is “event-driven”, prices will likely undergo a sharp reversal once global markets regain confidence. As such, fossil-fuel dependent countries have a narrow window of opportunity to enact pricing reforms, finance sustainable policy instruments such as smart-metering, and diversify energy generation base. Policy inaction will be a huge missed opportunity.
While a low oil price environment hurts the economies of major oil-exporting countries, they can be an economic lifeline for the struggling economies of oil-importing countries. In the Middle East, countries like Lebanon, which are heavily dependent on oil and oil-index fossil fuels to generate power, are particularly poised to get some relief.
Oil markets were already oversupplied, partly because of the US shale oil production, before the pandemic outbreak. Then, the coronavirus deeply affected oil markets through the weak oil demand of China, later aggravated by the spread of the virus and the consequent slowdown (or rather shutdown) of global economies.
“While a low oil price environment hurts the economies of major oil-exporting countries, they can be an economic lifeline for the struggling economies of oil-importing countries”
Moreover, coronavirus impacted oil markets through the heightened uncertainty and panic selling in equity markets, resulting in Dow’s worst decline since 1987. Adding salt to injury, Saudi Arabia and Russia, two of the world’s oil producers engaged in a price war following the collapse of their alliance in the OPEC+ meeting earlier this month. Both countries are currently fighting to preserve and increase their market share. For instance, Saudi Aramco has stated its goal to raise oil output to 12.3 million barrels per day in April and has offered record discounts by $8 per barrel of its Arabian Light crude oil to European refineries.
Overall, the oil market is facing a concurrent demand and supply shock with oil overproduction, due to the fallout of OPEC+ meeting, as well as the falling demand for jet fuel, gasoline, and diesel consumption due to the lockdown and other preventive measures restricting displacement following the coronavirus outbreak.
This unstable environment also leads to high volatility in oil markets and their proxies (indexed gas markets and other petroleum derivatives), which is, however, regarded as a transient effect. In fact, oil prices manifest themselves in cycles of high and low environments, which are often triggered by either “engineered” or unexpected shocks such as the one we are currently living.
Oil-dependent energy utilities in importing countries, such as EDL in Lebanon, can take advantage of low oil prices to improve their balance sheet, especially given their high levels of debt and subsidization. This move would indirectly benefit the states, since, for instance, the accumulated costs for Lebanon to subsidize EDL amount to roughly 40% of the country’s public debt since 1992. In the past, oil-importing countries in the Middle East, owning narrow source diversification in their energy mix, did not fully exploit the oil price slump to decrease their debt and carry forward structural reforms.
“Oil-dependent energy utilities in importing countries, such as EDL in Lebanon, can take advantage of low oil prices to improve their balance sheet, especially given their high levels of debt and subsidization”
Therefore, a key question regards how these energy utilities can fully take advantage of a low oil price environment, both in terms of direct effects as well as structural reforms in the energy sector. Here are a few ideas:
Energy utilities should fill their storage facilities to the maximum capacity and buy future contracts, following the example of the US, to secure an optimal oil price level for the years to come. In case of a shortage in accessing storage facilities, private ones can perhaps be rented, and if volumes are large enough, the per-barrel cost of storage should be marginal.
Energy utilities could potentially engage in a measured hedging strategy to mitigate future price hikes, given the cyclicity of oil prices. By doing so, they would be able to extend the time of their exposure to low oil prices vis-à-vis the spot international oil markets, which are highly volatile and unlikely to have lower oil prices than nowadays. This strategy has been adopted in Egypt, which has hedged against oil prices in both fiscal years 2018/2019 and 2019/2020.
Oil-importing countries should seek the opportunity to carry out structural reforms to their energy sector. They should reinvest savings resulting from low oil prices into more sustainable solutions, both in economic and environmental terms. Examples include financing smart metering and upgrading the grid, which would allow for better introduction of renewable energy sources in the energy system and contribute to the diversification of the country’s energy mix, enhancing its energy resilience.
Another structural reform regards the introduction of gas contracts with gas-on-gas based prices to shift away from the complete dependence on oil-indexed gas prices, since gas producing countries might be more willing to negotiate these terms in a low oil price environment.
In conclusion, while the coronavirus outbreak has greatly affected oil markets and the global economy extensively, oil-importing countries in the Middle East should see the opportunity in every difficulty and take advantage of financial instruments to keep oil prices low for longer periods than on the international oil spot market. It is also high time for these countries to exploit these advantageous conditions to bring about long-needed changes to their energy sector to ensure secure energy supply in a sustainable energy system.
Benedetta Bonometti, researcher at the Future Energy Program (FEP) of Fondazione Eni Enrico Mattei, and a graduate student in public policy with a specialization in energy, resources, and development at Sciences Po Paris. Her research interests focus on fossil fuel and nuclear energy policies and socio-economic development and governance in the Middle East.
Ali Ahmad, Director, Energy Policy and Security Program, Issam Fares Institute for Public Policy and International Affairs, American University of Beirut.
This article is part of a new series launched by the AUB Issam Fares Institute to reflect on the impact of the #COVID-19 pandemic on various levels: the economy (global, and national), globalization, multilateralism, international cooperation, public health systems, educational system, refugee response, among other topics.
Opinions expressed in these articles are those of the author and do not necessarily reflect the views of the Issam Fares Institute for Public Policy and International Affairs at the American University of Beirut.
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