Oil rig near the mountains in Norway.

Shell Impairments Support Bearish Market

In contrast to the current optimism in the MSM about oil prices, increased demand and a possible return of global economic growth, the Dutch IOC put a huge damper on the latter. As already stated before current optimism in the market is not based on fundamentals but mainly on a perceived optimism at institutional investors and banks. The current upsurge in oil prices is still unfounded, as now also Shell reiterates by taking an impairment of between $15-22 billion for 2020.

With a slew of bad figures, the IOC is in line with British oil major BP’s actions the last weeks. The impact of the COVID-19 pandemic and its disastrous effects on energy demand and economic growth is slowly becoming clear some parties. Big Oil has been hit severely in Q2 2020, more than analysts have agreed upon before. As Shell stated none of its business groups has been left unscathed.

Not only the results in Q2 2020 has been dramatic, the company, as also stated by BP and others, but COVID and the unexpected oil and gas demand destruction will also have a long-term effect on commodity prices. The market slowly starts to realize that not only crude oil and natural gas/LNG has been hit, downstream at the same time has been hit too. The total write-down of $15-22 billion is dramatic, but maybe it will not even be the full amount in the coming years.

As indicated before, oil prices are hit and will be depressed for the long term. For 2020 higher price ranges almost are out of reach, as the drop in demand for crude oil and gas is still large. Some green leaves have been shown in Asia and some European countries, but the latter is still very weak. Re-emergence of COVID hotspots in EU and Asia, combined with continuing dramatic developments in the USA, Latin-America and Africa, are no real basis for higher price settings.

At the same time, the current crude oil storage volumes are still at historic high levels, leaving no real room for a surge in prices, even if demand would increase substantially. In its update, Shell reiterated that all positive signs in the market are very fragile.

The Dutch major indicated that its own oil-product sales volumes are expected to be between 3.5 million to 4.5 million bpd in Q2 2020, which is a dramatic 3.1-2.1 million bpd drop from the same period last year.

Market analysts should however look not only at the overall production or delivery figures but at the company’s assessments of oil prices in the coming years. For 2020, Shell, as BP, is much less bullish than financial institutions such as Bank of America (BofA)or others. BofA’s Global Research team stated last week that it lifts its oil price forecast for this year and next as demand recovers from coronavirus-linked shutdowns, the OPEC+ output cut deal curtails supply, and producers slash capital expenditure.

The bank expected Brent crude oil averaging $43.70 per barrel in 2020, up from a previous estimate of $37. In 2021 and 2022, the bank forecasts average prices of $50 and $55 a barrel respectively. BofA also forecast that “a pattern of falling inventories across most regions should emerge as we move into H2 2020. This optimism is clearly out of reach with real fundamentals on the ground. Norwegian consultancy Rystad Energy, however, has warned that the downside risk in oil markets is still very much alive. In its report Shell stated that it expects a Brent oil price of $35 for 2020, reaching $40 per barrel in 2021, $50 2022 and 46$ in 2023. Even that the price expectations are based on long term 2020 real terms, even these figures look for 2020-2021 still a bit optimistic.

Taking into account Shell (and BP) reporting, the short-term looks bleak. At least 2020 in plain terms looks like a possible write-off. If optimism on share markets is also hit by reality, a new negative spiral could hit markets. When only looking at fundamentals, combined with increased economic and geopolitical unrest globally, there is no real justification for oil market optimism in 2020. The next 6 months will be very volatile. Optimism should instead be pointed towards 2021. The price upward potential for 2021 is clearly available.

Low investments upstream, combined with large-scale shutdowns and bankruptcies are prime factors to take into account. Even if demand stays subdued, the market could change from a demand-driven to a supply constraint market. An average crude oil price (Brent) of above $40 per barrel is wishful thinking in 2020. 2021 could be bullish, pushing the bears back into hibernation. When looking at share prices, 2020 is however already interesting, if you have a long-term view. Current PE levels are still reasonable, but will most probably become hot end of 2020 – beginning 2021.