By: Robert Bickhart, Julie Francis
One of the most significant dynamics of COVID-19’s global spread was illuminating the processes that underlie our hyper-connected and technologically advanced world. Dramatic shifts in societal behavior led to serious ramifications for many industries, particularly the enterprises that comprise the energy supply chain.
Contemporary society is deeply dependent on energy, of which oil and gas are a key source; these resources power transportation, keep buildings comfortable, and so much more.
While oil and gas have always been vital to keep industries humming along, production and distribution is ultimately at the mercy of supply and demand and COVID-19 played havoc with those patterns. Indeed, these market dynamics shifted more abruptly and significantly than any other point in contemporary history, leading to short-term shocks that may facilitate long-term changes in the industry and the risk environment for individuals and businesses alike.
Quick overview: What does the oil and gas supply chain look like?
At a high level, the supply chain to generate crude oil, convert this asset into a product, and ultimately sell to the end user involves upstream and downstream processes. Upstream oil and gas production involve the extraction and mining of raw materials, well drilling, and other activities that produce oil and/or gas.
These materials are then converted into a usable asset (e.g. diesel fuel, jet fuel, etc.) through downstream operations, typically at refineries and petrochemical factories. Figure 1. below illustrates the basic crude oil supply chain process. The “downstream” portion of this process is highlighted inside the red box.
Source: Wood Mackenzie
What happened when COVID-19 brought society to a standstill?
With aerial and vehicular transportation effectively paralyzed for some of March and April, downstream operations at refineries experienced a sudden demand shock. Typically, oil producers respond to falling demand by restricting supply; but in this instance, a price war between two global oil production leaders—Saudi Arabia and Russia—did the reverse and flooded the market with unneeded products.1 These dynamics contributed to oil prices turning negative for a brief period in April.2
Russia and Saudi Arabia eventually agreed to cut supply, and the summer months featured at least some semblance of travel, albeit at much reduced rates.3 4 This allayed some of the issues, but the fallout from the excess supply, increased crude inventories, and limited demand has proven to be too much to overcome for some downstream companies, leading to refinery closures and reduced run rates, as explained in the next section. Furthermore, a deeper dive into how refined products were consumed prior to COVID-19 indicates that there may not be much relief on the horizon for downstream enterprises in the months and years to come.
For example, nearly 35 percent of gasoline demand has historically derived from commuters driving to and from work. During the crisis, the vast majority of non-essential workers have been working remotely, and it’s anticipated that remote working will remain prevalent in the aftermath of COVID-19 as well.5 This has caused a change in demand for refined products, known as a yield shift. The initial stay-at-home orders caused a massive year-over-year yield shift in gasoline, jet, and diesel fuels.
Additionally, millions of other workers have lost jobs during the crisis, and it could take years for employment levels to return to pre-COVID levels.
Given these trends, as well as uncertainties with the continued lingering of COVID-19, the public and business personnel’s decreased willingness to fly, and perhaps a persistent slump in business travel due to increased remote work, there might not be much relief for the air travel industry. This could continue to suppress demand for jet fuel.
How have downstream operations responded, and what are some of the risks?
In response to these societal shifts, refineries across the United States have closed permanently, temporarily, or chosen to run at reduced rates. In terms of the risk landscape, each of these three scenarios poses its own set of risks.
- Permanent Refinery Closures - With populations locked down to slow the global coronavirus pandemic, demand for oil products collapsed and, with it, the market for oil. The response has not been pretty for downstream assets, and many refineries fell into negative margin territory as a result. Historically, many of the refineries that have closed have been converted to terminals. Although this maintains operations at the site and reduces some remediation costs, the employment levels are significantly lower than for refinery operations–contributing to a large societal impact that can’t be discounted.
- Temporary Refinery Closures - Just like a car owner may be reluctant to start a car after it sits in a garage for an extended period, refinery owners are also hesitant to temporarily close a refinery due to the risks involved with restarting. The process of getting a closed refinery running again typically requires hundreds of contractors using different types of heavy equipment. This may increase the possibility of workplace accidents.
- Reduced Refinery Run Rates - Running a refinery at a reduced rate—both during and after the pandemicposes another risk. Refineries make money on margin, which is the monetary conversion of cheaper crude feedstock to a more expensive refined product. To prevent the total loss created from a refinery closure, a refinery operator may decide to reduce the refinery operation. However, risks are introduced with running at lower utilization, especially running refinery utilization below 65 percent of capacity, which may damage the refinery units.
Demand shocks will have an impact on upstream processes as well
Diminished demand for refined products has implications for upstream operations too. Prior to COVID-19, the U.S. hydraulic fracturing boom in the 2010s doubled crude production and increased gas production by two-thirds. But, like other commodities, oil and gas production responds quickly to falling product prices, which is what transpired this past spring in the midst of the pandemic. The horizontal oil rig count fell by 75 percent this past March and stayed low as West Texas Intermediate oil price remained stagnant at around $40/bbl through the summer. We expect a gradual increase in drilling activity in 2021, but U.S. oil and gas production rates will take time to recover. For context, in 2014, when oil prices dropped from over $100 per barrel to under $60, operators sharply cut drilling from peak activity levels.
The benefits of falling demand: Fewer gas flares
Since 2015, oil and gas production has outpaced gas pipeline capacity. To keep oil production flowing, this oversupply has resulted in growing volumes of an oft-cited health and environmental concern: Gas flares. Gas flaring has been linked to the emission of compounds that could have deleterious effects on human health and the environment. Among many other compounds, gas flaring emits carbon dioxide and, depending on the composition of the gas, may also release carbon monoxide, sulphur dioxide, and nitrogen dioxides.6
A 2012-2015 study of roughly 23,000 births in the Eagle Ford Shale region in Texas found that pregnant women living within three miles of an oil and gas well were 30 percent more likely to experience pre-term birth than those who did not reside there. Additionally, women exposed to ten or more flares during pregnancy were 50 percent more likely to give birth prematurely than women with no exposure to these wells.7 8
A pandemic-induced reduction in upstream activity beginning in April has yielded less gas flaring in 2020. Wood Mackenzie data indicates that flaring in the Southwestern United States (in the Permian Basin) in August dropped 35 percent from January levels, down 50 percent year-on-year. In August, flaring in North Dakota’s Bakken region fell 30 percent since the start of the year, 65 percent lower than August 2019.
In addition, producers are finding innovative ways to curb flaring. Using field gas to electrify their own operations cuts diesel consumption while burning less methane. One company re-injects gas using a solar-gas hybrid compressor. Even before activity slumped, some investors began demanding more environmentally sustainable operations. That investor pressure has only continued to increase.
The health and environmental risks of “orphaned wells”
Lower oil prices make the viability of some upstream enterprises tenuous. Low-producing wells have become uneconomic, accelerating the need to plug them. And as some oil and gas companies go bankrupt, more old wells may become “orphaned” wells without a clear owner. The cost to plug wells can sometimes fall to state and local governments when no solvent or known company can be held responsible. However, without addressing this situation, there may be implications for human health and the environment. Here are some examples:
- Although wells are designed to isolate aquifers from hydrocarbon layers, occasionally old abandoned wells can contaminate local water supply. A study published in 2011 by the Groundwater Protection Council indicated that, of 185 groundwater incidents recorded in Ohio from 1983-2007, 22 percent were caused by orphaned wells.9
- Abandoned or inactive wells also emit methane. This greenhouse gas is more efficient than carbon dioxide at trapping heat in the atmosphere, though it stays in the atmosphere for a shorter period of time than carbon dioxide. Methane can also impact the health of those in proximity to these wells, causing nausea, dizziness, and shortness of breath.10 The EPA reported that in 2018, 3.2 million abandoned wells in the United States released 281 kilotons of methane into the atmosphere, which is the equivalent of burning 16.2 million barrels of crude oil. Methane emissions from plugged wells average 1 percent of those from unplugged wells, highlighting the need for that final step.11 12
As more onshore U.S. crude oil and natural gas wells approach the end of their economic life, it remains to be seen how many of these will go unused and need to be permanently plugged.
Source: Wood Mackenzie
Could more refineries shift to the production of biofuels?
From an environmental perspective, the massive disruptions caused by the COVID-19 outbreak might produce some positive impacts in both the long term and short term. In the long term, the reductions in demand for refined fuels has prompted a renewed look at transitioning to cleaner, renewable sources. New technologies, greater energy efficiencies, and large carbon removal deployments are essential for energy transition. But there are commodity demand risks that could change the pace of scale of the energy transition.
Source: Wood Mackenzie. *Relative to base case. Color scheme shows positive (green), neutral (yellow) and negative (red) impact on commodity demand.
The United States is beginning to see these effects in the short term, as different U.S. refineries have pivoted to using their facilities to develop renewable biodiesel. Of course, while the pandemic was an impetus for this transition, there are other reasons why such a dramatic shift was being contemplated. Here are a handful:
- Institutional investors and hedge funds are looking to invest in more sustainable projects, while withdrawing capital from oil and gas investments.
- Current government policies incentivize renewable projects, such as the generation of clean energy credits (biofuel credits, renewable identification numbers, etc.) that are traded on the open market.
- A general reduction in carbon dioxide emissions to meet global commitments, which is occurring largely in Europe, could also spread to North America. Major operators are planning for long term industry changes that support environmental goals contributing toward a sustainable future.
- Customer sentiment is increasing the demand for alternative and more renewable options, such as electric vehicles.
While emission levels for these biodiesel facilities aren’t zero, they are better for the environment than their oil processing predecessors. They use organic feedstock and recycle waste material to create sustainable refined products. However, converting plants to generate biofuels carries its own risks. For example, similar to reopening a temporarily closed facility, the conversion process would involve increased personnel and raise the chances for a workplace accident.
Peering into a post-COVID future
The COVID-19 outbreak had major implications for upstream and downstream operations in 2020. But many questions loom as we ponder how these ripple effects will shape these industries – and their surrounding environment – in the years to come. Could there be a surge in hazardous orphaned wells? Will these wells be plugged? Will more refineries soon be converted to generate more sustainable product lines, as some did during the pandemic, or will a broader transition take years to undertake?
From drilling to distribution, these are just a few of the considerations involved, and the risk environment stands to be affected considerably. Monitoring these developments will be crucial for risk professionals to ensure that the exposures of the present – and future – can be managed effectively.
Robert Bickhart is research manager, oil analytics and research, Wood Mackenzie at Verisk. Robert can be reached at Robert.Bickhart@woodmac.com.
Julie Franci is principal analyst, lower 48 upstream research, Wood Mackenzie at Verisk. Julie can be reached at Julie.Francis@woodmac.com.
1. Weizhen Tan, “Oil prices fall to 17-year low as Saudi Arabia-Russia standoff continues, coronavirus hits demand,” CNBC, March 30, 2020, < https://www.cnbc.com/2020/03/30/oil-falls-amid-saudi-arabia-russia-price-war-coronavirus-hits-demand.html >, accessed on November 12, 2020.
3. “TSA checkpoint travel numbers for 2020 and 2019,” Transportation Safety Administration, < https://www.tsa.gov/coronavirus/passenger-throughput >, accessed on November 12, 2020.
5.“When everyone can work from home, what’s the office for?” PWC, June 25, 2020, < https://www.pwc.com/us/en/library/covid-19/us-remote-work-survey.html >, accessed on November 12, 2020.
6. “Natural Gas Explained,” U.S. Energy Information Administration, September 24, 2020, < https://www.eia.gov/energyexplained/natural-gas/natural-gas-and-the-environment.php >, accessed on November 12, 2020.
7. Julia Rosen, “Study Links Gas Glares to Preterm Births, With Hispanic Women at High Risk,” New York Times, July 22, 2020, < https://www.nytimes.com/2020/07/22/climate/gas-flares-premature-babies.html >, accessed on November 12, 2020.
8. “Living near natural gas flaring poses health risks for pregnant women and babies,” University of South Carolina, July 17, 2020, < https://hscnews.usc.edu/living-near-natural-gas-flaring-poses-health-risks-for-pregnant-women-and-babies >, accessed on November 12, 2020.
9.“State Oil and Gas Agency Groundwater Investigations and Their Role in Advancing Regulatory Reforms,” Groundwater Protection Council, August 2011, < http://www.gwpc.org/sites/default/files/State%20Oil%20%26%20Gas%20Agency%20Groundwater%20Investigations.pdf >, accessed on November 12, 2020.
10. Nichola Groom, “Special Report: Millions of abandoned oil wells are leaking methane, a climate menace,” Reuters, June 16, 2020, < https://www.reuters.com/article/us-usa-drilling-abandoned-specialreport/special-report-millions-of-abandoned-oil-wells-are-leaking-methane-a-climate-menace-idUSKBN23N1NL >, accessed on November 12, 2020.
12. “Inventory of U.S. Greenhouse Gas Emissions and Sinks 1990-2018,” United States Environmental Protection Agency, April 13, 2020, < https://www.epa.gov/sites/production/files/2020-04/documents/us-ghg-inventory-2020-main-text.pdf >, accessed on November 12, 2020.