Oil & Gas Q2 2023 Insights: A Shifting Landscape

Oil prices have declined significantly since April 2023, which is attributed to the OPEC+ production cuts and concerns about global economic health impacting oil demand growth. Similarly, natural gas prices experienced a consistent decline globally but remained relatively high from a historical perspective.

Since reaching their peak in April 2023, oil prices have experienced a significant slump, leading to reduced expectations for global oil demand growth. During the period from April 12, 2023, to May 4, 2023, the Brent crude oil price declined by $16 per barrel (b) to $73/b, and the West Texas Intermediate crude oil price dropped by $15/b to $69/b. Throughout June, benchmark crude oil prices remained constrained within a narrow range, primarily due to prevailing economic challenges, which had a more notable impact compared to the increased supply cuts implemented by specific OPEC+ nations. Despite lower production levels from Saudi Arabia and core OPEC+ members since the initial implementation of production cuts in November, this decline has been compensated by higher output from other oil-producing countries. As of June, the global oil supply was only 70 kb/d below the levels observed in October, just before the first round of OPEC+ cuts took effect. However, oil prices could rebound in the second half of the year, driven by the latest supply cuts initiated by OPEC+ and an increase in demand from China.

During the second quarter of 2023, natural gas prices experienced a consistent decline. By the end of the quarter, the U.S. benchmark Henry Hub natural gas spot price had dropped below the levels observed during the summer of 2021. However, it remained significantly higher than historical averages. Similarly, spot prices in Europe and Asia continued to plummet due to weak demand and excessive inventories in major markets. In fact, in the second quarter of 2023, European and Asian spot prices were, on average, 60% lower than during the same period in 2022. Yet, they remained relatively high from a historical perspective. Consequently, the current market outlook does not anticipate any significant supply tensions soon. However, it is essential to note that this perspective could change depending on weather conditions, as they continue to be the primary factor contributing to risk and uncertainty in the natural gas market.

Strained Alliances and Market Challenges: OPEC+ Seek Stability in Oil Prices

On June 4, OPEC+ members gathered in Vienna, Austria, for a two-day meeting to review their current production strategy. New oil production cuts were expected to result from the meeting as signs of discord between top crude oil producers Saudi Arabia and Russia would potentially set the tone of the talks.

Following the meeting, the 23 participating countries made no changes to OPEC+’s planned oil production cuts for this year. They decided to further cut their production in 2024 in response to the ongoing downward trend in oil prices.

Indeed, recent market trends, such as fears of a global economic crisis, rising interest rates by major central banks, weak demand from China following the termination of anti-Covid regulations, and the Ukraine war, are weighing on oil prices. The alliance has therefore decided to maintain the April production level (October 2022 quota plus voluntary cuts announced between February and April 2023) until the end of the year. It has set the production level for 2024 at 40.46 Mb/d, around 2% lower than in 2023, to boost oil prices. Barring brief exceptions, oil prices have been falling for about a year while producers face a looming supply glut. In June 2022, a barrel of OPEC oil cost around $115 and is currently around $75.

This was a complex deal to reach. Before the meeting, tensions between Saudi Arabia and Russia had risen. While the price increase favours the former and the Gulf states, it does not benefit the latter. Indeed, due to international sanctions, Moscow cannot deliver oil over a set price per barrel.

Simultaneously, Saudi Arabia announced an additional voluntary drop of 1 million barrels per day cut starting this July, bringing its output to 9 Mb/d for a theoretical capability of 12M b/d. The reduction may be extended depending on market conditions. On the other hand, the US is set for record annual oil production, surpassing the old record of 12.3 million barrels per day.

Analysts, including those at OPEC and the IEA, had already anticipated a tightening of supply in the second half of 2023, given the existing OPEC+ production policy. Also, given Saudi Arabia's history of fulfilling its output commitments, analysts perceive that the initial impact of the deal will be a reduction in supply. Finally, JP Morgan estimates that OPEC+’s decision will reduce supply in 2024 by almost 1.1 million bpd compared to its previous expectations. However, the perception of tighter supply is not entirely the result of OPEC+’s production cut agreement as US crude oil stocks tightened while demand for petroleum products improved.

UK Government Implements Energy Profits Levy Reform to Address Fluctuating Oil and Gas Prices

Members of OPEC+ are not the only ones reacting to declining market trends. The British government announced a reform to the Energy Profits Levy on June 9 to safeguard energy firms from significant decreases in the barrel price. If oil and gas prices fall to or below $71.40 per barrel and £0.54 per therm for two consecutive quarters, the windfall tax will be abolished. Otherwise, the tax will be applied until March 2028.

To recall, the windfall tax was implemented last year to support the government's initiative of lowering household and business energy costs. The 25% Energy Profits Levy, which applies to profits generated by the production of UK oil and gas (but not from other activities such as refining oil or selling petrol and fuel on forecourts), was implemented in May 2022 by Prime Minister Rishi Sunak as chancellor and was set to expire in 2025. The incumbent Chancellor, Jeremy Hunt, indicated in April 2022 that the levy would be raised to 35% in January 2023 and last until March 2028.

To date, the Energy Profits Levy has raised almost £2.8 billion, assisting the government in paying slightly under half of the average family energy bill last winter. The government anticipates raising approximately £14 billion over the next six years.

Under normal circumstances, corporate profits from oil and gas companies operating on the UK continental shelf are taxed at a rate of 40% rather than the regular 19%. The levy lifts the tax rate to 75% for companies like BP and Shell. Since its implementation, energy firms have urged authorities to decrease the windfall tax, expressing concerns that it is leading them to limit investment. For instance, Harbour, the UK's largest oil and gas producer, announced in April that the windfall tax would result in the loss of 350 UK onshore jobs. TotalEnergies, the French oil giant, said it will reduce its planned 2023 North Sea investment by a quarter, or £100 million, due to the extension of the windfall tax. While market conditions at the time of the tax's implementation would have caused oil prices to rise, prices have dropped in recent months.

According to the government, this situation jeopardises the long-term future of the UK's domestic supply, requiring the UK to import more from overseas when families and businesses are looking for reliable and inexpensive energy, and thus contradicts its initial objectives, hence the tax evolution.

As Natural Gas prices continuously decline over Q2 2023 as supply remained abundant

Since the start of 2023, pressure on both the European and global gas markets has notably alleviated thanks to favourable weather conditions and timely policy actions. This relief has led to a noteworthy drop in the prices of European hub and Asian spot liquefied natural gas (LNG) by the end of Q1 2023, bringing them below their levels observed during the summer of 2021.

The decline in prices persisted throughout the second quarter of 2023, with European spot prices averaging $11.3 per million British thermal units (MBtu) or €35.4 per megawatt-hour (MWh), while Asian spot prices averaged $11.1/MBtu. These figures represent a decrease from the previous quarter's prices but remain twice the historical average. Similarly, the spot price of natural gas in the US dropped by 19% in the second quarter compared to the previous one, reaching its lowest level since September 2020.

This downtrend can be attributed primarily to the weak global demand for natural gas that has been ongoing, along with high stock levels and increased LNG imports in Europe, as well as surplus domestic production in the US and sufficient inventories in Asia amid stable weather conditions. In fact, the substantial decrease in natural gas demand has led to reduced storage withdrawals in both Europe and the United States. This resulted in inventory levels at storage sites surpassing their five-year average by the end of the heating season. Consequently, there may be a decline in injection demand over this summer and a possible easing of market fundamentals.

However, it is essential to note that the improved outlook for gas markets in 2023 does not guarantee immunity against future volatility. In fact, despite the positive developments, the global gas supply is still expected to remain tight throughout 2023, and the overall market balance is susceptible to an unusually broad range of uncertainties. These uncertainties encompass numerous factors, including adverse weather events like a dry summer or a cold Q4, diminished LNG availability, and the possibility of further declines in Russian pipeline gas deliveries to the European Union.

The financial sector divests from fossil fuels and governments pave the way for alternative energy sources

In response to mounting pressure from activist groups and public criticism, many banks have decided to cease financing new natural gas or oil field projects. This reflects a larger shift within the banking sector as institutions increasingly recognize the importance of aligning their financing activities with the global transition towards a sustainable and low-carbon economy.

In fact, BNP Paribas has announced additional measures to align its financing practices with a low-carbon future, building upon its January commitment to reduce oil exploration financing by 80% by 2030; the French Banking group has said it will no longer finance new gas field projects joining other leading fossil fuel lenders such as HSBC that announced in late 2022 it will stop the funding of new oil and gas fields.

On the other hand, governments are embracing alternative energy sources, with hydrogen taking center stage in strong development policies aimed at replacing natural gas for various applications, such as heat and electricity production. Notable initiatives include the adoption of the Inflation Reduction Act in the United States in 2022, which represents significant public support for the hydrogen industry, accelerating the learning curve and enabling costs to decline, as well as the announcement of the construction of H2Med pipeline supplying France and Germany from Spain and Portugal. The pipeline, expected to be operational by 2030, is intended to transport approximately two million tons of hydrogen to France each year, representing 10% of the estimated hydrogen needs of the EU.

Another promising alternative to natural gas is e-methane, a synthetic methane produced from electrolytic hydrogen that can be used interchangeably with natural gas. E-methane can potentially play a significant role in decarbonizing existing gas networks. However, its complex value chain currently entails high investment costs and operational expenses. Japan is among the early adopters in this emerging market, as outlined in its 6th Strategic Energy Plan, which sets ambitious targets for synthetic methane adoption, aiming for 1% of the gas supply in existing networks by 2030 and up to 90% by 2050.

With the increasing need to reduce greenhouse gas emissions, oil and gas companies are actively expanding and diversifying their activities. One significant approach to diversification is through Carbon Capture Utilization and Storage (CCUS). This market has experienced considerable growth and visibility in recent years, driven partly by initiatives from industrial actors and public incentives.

The Global CCS Institute annually monitors trends in the global Carbon Capture and Storage (CCS) market. Their latest publication for 2022 indicates a prosperous year for CCS, surpassing the previous years, with monthly project announcements. As of September 2022, the CCS installation pipeline, which includes transport and storage projects, comprised 196 projects (two of which were cancelled). This represents a 44% increase in the number of CCS installations compared to the previous report. Notably, the Bayu-Undan project in Australia, led by Santos, is anticipated to be the world's largest CCS project awaiting approval in 2023. Additionally, Norway is considering five proposals for carbon dioxide storage in the North Sea, highlighting the growing interest in CCS.

While not all oil and gas firms participate in these initiatives, their involvement remains significant, primarily through the Oil and Gas Climate Initiative (OGCI), an international industry-led organization which includes 12 member companies from the oil and gas industry: BP, Chevron, CNPC, Eni, Equinor, ExxonMobil, Occidental, Petrobras, Repsol, Saudi Aramco, Shell and TotalEnergies. Leveraging their practical knowledge of the subsurface, oil and gas companies play a crucial role in the development of CCUS. The OGCI has actively collaborated to establish CCUS hubs and sought to contribute to the market's growth.

In a groundbreaking initiative, the American Bureau of Shipping (ABS), in partnership with global maritime organizations and the OGCI, has received preliminary authorization to employ carbon capture technology on an oil tanker. This pioneering project aims to demonstrate the feasibility of capturing carbon on board a ship. The consortium is now poised to proceed with the engineering, procurement, and construction phases.

Recent regulatory advancements have also been observed, including Malaysia's proposal for a CCS tax incentive and modifications to the Oil, Gas, and Salt Resources Act to remove the Ontario CCUS restriction. These developments underscore the increasing recognition and support for CCUS in various regions.

Overall, the growing interest in CCUS and the active involvement of oil and gas companies, alongside collaborations such as the OGCI, show a concerted effort to drive innovation and address greenhouse gas emissions within the industry.