By Glada Lahn and Siân Bradley, Senior Research Fellows, Energy, Environment and Resources Programme
This blog is part of a series on tackling COVID-19 in developing countries. Visit the OECD dedicated page to access the OECD’s data, analysis and recommendations on the health, economic, financial and societal impacts of COVID-19 worldwide.
For oil and gas exporters, COVID-19 has caused a downturn like no other. From early 2020, lockdowns sent global energy demand plummeting by over a quarter. Combined with the Saudi-Russia price war, oil prices hit their lowest levels in over two decades, down to less than $20 a barrel in April. Without strategic reserve filling, the collapse would have been even steeper. As lockdowns eased and June’s OPEC-plus agreement to cut production boosted oil prices (around $40/b in June), producer countries could be forgiven for hoping that the worst is over. However, as the pandemic hit, the fossil fuel market was already facing a grim prognosis.
From boom and bust to… bust
Five years ago, Chatham House began exploring what decarbonisation might mean for extractives-led development. To achieve the Paris Agreement’s commitment to limiting global warming to well below 2°C and as close as possible to 1.5°C, all credible pathways will require a radical reduction in fossil fuel use. With 76 per cent of all greenhouse gas emissions (GHGs) and close to 90% of CO2 emissions coming from the burning of coal, oil and gas, the implications for these markets are profound. We are no longer talking about a cycle of boom and bust, but about structural decline.
This structural shift will not only be driven by policies to constrain carbon. Advances in technology and changes in investor appetite (and social acceptance of fossil fuels) are undeniable. The cost of clean energy systems – including renewable energy and storage – already undercut fossil fuels in most regions. Price parity between electric vehicles and internal combustion engines is now expected by the early to mid-2020s.
While global financial centres are assessing their exposure to climate-related risks, there remain few comparable discussions in lower-income fossil fuel-dependent countries, which are least resilient to these shifts.
So how is COVID-19 affecting this picture?
The end of fossil fuel-led growth
Neither the governments of countries with oil and gas reserves, nor their development partners have paid much attention to planning for the ‘worst-case’ price scenario, and it has proven difficult to lower expectations around the sector. Since 2018 Chatham House has run scenario-analysis workshops with producer countries, and in each, the concept of a long-term collapse in average oil prices – from $60/b (IEA projection) to $20/b – was met with surprise and comments like ‘our reserves wouldn’t be worth producing at that price’! By April 2020, that’s exactly what happened, and gas prices followed suit, providing something of a test run of what demand destruction looks like.
The impact on national balance sheets comes in the wake of two earlier crises – the 2008-9 financial crisis and the 2014 oil price crash. Even for richer countries, the cushion is depleting; in the five years before lockdown, Saudi Arabia had already drawn down over one third of its foreign reserves and borrowed more than $19bn. US fracking companies began filing for bankruptcy, unable to service their debt. Whilst the IMF moved quickly to halt debt servicing for the poorest and urged others to do so, greater debt is inevitable. Nigeria took a $3.4billion IMF loan in April, adding to its pre-existing $27 billion debt burden and countries like Algeria and Iraq slashed public spending, further testing fraught social contracts.
COVID-19 compounds the uncertainties that producer countries face. There are conflicting drivers of demand and investment in fossil fuels, given a looming global recession and the range of government recovery measures, with some seeking a ‘return to normal’ and others aiming to catalyse green growth. This uncertainty justifies countries putting ‘market risk’ front and centre in their policy and planning. Established producers will want to accelerate economic diversification, while early and prospective producers like Mozambique, Guyana and Uganda may want to revise the role of fossil fuels in their economies and avoid falling into the same trap.
Recovery packages could reshape energy and industrial pathways
Economic stimulus and jobs will be a top priority for every government in the coming months, and for development assistance. Yet it is becoming harder to secure investment in power and industrial infrastructure linked to export projects. International oil companies (IOCs) were already facing a crisis in their business model and now face pressure to rein in spending. They are unlikely to snap up ‘cheap’ assets as they did following previous downturns, and will be even more reluctant to invest in thermal power systems. Resource-backed loans may still be on the table, but with even less favourable terms than before. Multilateral financing will continue but following initial untied emergency loans, will likely require approaches that enhance the resilience of investments, including to climate-related risks.
While the development of carbon-intensive energy systems and industries such as petrochemicals and steel might have made sense in the 1960s, 70s and 80s, it is folly for new market entrants today. The Gulf Cooperation Council (GCC) countries and Trinidad and Tobago are commonly seen as the ‘success stories’ of fossil fuel-led industrialisation but they are now struggling to reduce systemic inefficiencies and create jobs for the modern economy. The COVID-19 crisis presents an opportunity for producer countries wanting to follow these examples to think instead about how they can exploit their competitive advantages in growth areas such as the digital economy, sustainably produced food, and biodiverse landscapes. However, they will need support to do so, making the alignment of multilateral finance with climate goals more vital than ever.
Increasing scrutiny of public costs and liabilities
State support to fossil fuels and carbon-intensive sectors such as aviation feature prominently in the initial recovery measures announced by the US, Chinese, Russian, Canadian, Australian and UK governments, amongst others. India has doubled down on coal mining. If taxpayers are keeping companies afloat, then the extent to which they serve the public interest will come under much greater scrutiny. In many developing countries, extractives companies are already in public hands and financed directly from resource revenues or through the national budget. The Natural Resource Governance Initiative has shown that, in at least 25 countries, the national oil company collects revenues equivalent to more than 20 percent of all government revenues and many carry substantial liabilities. State support for fossil fuel interests throughout the COVID-19 crisis should serve to reveal the scale of state support to the sector and risks to public finance that it entails.
If the COVID-19 crisis teaches us anything, it is the importance of trust between government and civil society, and of accurate and timely data. Public debates about the risks associated with fossil fuel dependency are long overdue. Information about emerging policy and market trends, including climate-related risks, needs to flow much more readily from advanced economies to developing ones, and between different stakeholders within producer countries, in order to enhance resilience and enable a fairer transition. Existing transparency fora such as the Extractive industries Transparency Initiative (EITI) would be a good place to start.
A chance to break the cycle
This is no ordinary downturn. In the coming years, economic readjustment will take place alongside the increasing physical impacts of climate change, hitting lower income countries hardest. The COVID-19 crisis could accelerate the global transition or reinforce carbon dependencies, setting the world on track for a later – and even more disruptive – reset. Either way, recovery measures could give established producer countries a chance to break their cycle of rent dependence, and emerging ones the option to avoid it altogether.