The spread of Covid-19 poses a significant threat to the global oil and gas industry. The increasingly drastic action taken to reduce the spread of the virus interferes with many of the sector’s key processes: offshore workers have to balance maintaining social distancing while living and working in confined spaces; travel bans and quarantines inhibit companies’ ability to travel and conduct meetings; and the uncertainty that runs through the pandemic does nothing to reassure a historically volatile industry.

This uncertainty is furthered by the lack of an obvious historical precedent for the phenomenon in the oil and gas sector. The International Energy Agency (IEA) has pointed to the 2003 SARS pandemic as a loosely analogous event, but noted that a centrepiece of both the Covid-19 outbreak and the global oil industry, the part played by China, has changed dramatically in the last two decades. 

As the agency notes, since 2003, China’s oil demand had more than doubled, and by 2019, Chinese growth accounted for more than 80% of global oil demand growth.

The disruption to Chinese oil has had repercussions felt around the world; in February, the IEA noted demand had fallen by 435,000 barrels per day (bpd) in the first quarter of this year alone, the first quarterly contraction in demand in more than a decade.

The following month, the agency reported that the shutdown of the Chinese economy in the wake of the virus has triggered a collapse in global oil demand of 1.1 million bpd compared to 2019 figures, and slashed its annual growth forecast by more than a quarter, to 825,000 bpd, the lowest growth figure since 2011.

Energy research firm Rystad Energy went a step further, predicting that a 25% decline in oil prices could see oil and gas investments cut by $30bn globally, severing an economic lifeline for an industry that has already been casting its eye towards long-term decommissioning projects rather than new drilling opportunities. As a result, the pandemic could prove to be an existential threat for the oil and gas industry, as social and economic challenges force a historically conservative sector to adapt to a rapidly changing environment. 

While there are some causes for optimism, notably the industry’s response to the 2014 oil crash providing a basic framework for future crisis management strategies, it remains unclear if the oil industry is properly structured to respond to this emergency.

The sudden spread of Covid-19 has plunged many of the world’s oil production centres into limbo, with closures and uncertainty in China leading the way. According to Carbon Brief, the percentage of oil refineries in operation in the province of Shandong fell from 71.4% in December 2019 to 38.9% two months later, a collapse of close to half that is symbolic of a wider, sudden industrial outage. Similarly, government figures have shown a 3.3% decline in crude oil processing in the first two months of the year, compared to the same period in 2019, and a 6.6% fall in the production of refined oil.

This decline in production has precipitated a near-identical decline in oil prices. Figures from Trading Economics show that the price per barrel of oil has collapsed in the last four months, from a peak of $64.58 on 5 January to a low of $20 on 1 April. This drop has been hastened by two periods of significant declines: a fall from $47.80 to $30.16 between 5 and 9 March, and a fall from $33.33 to $20.23 between 13 and 18 March.

These last two figures are beyond the scope of the reports released by the Chinese Government, which found some positive outcomes in a 3.5% increase in total crude oil production compared to the first two months of 2019. There is a real concern that after this brief bubble, oil production across China could be plummeting.

These twin challenges have created twin problems, with social and economic costs of the virus tied at the hip.

“There are two avenues that companies are thinking about right now,” said Yvonne Telford, senior analyst for north-west Europe at Westwood Global Energy, highlighting these issues. “The health and safety of the workers, maintaining the security of supply through this crisis; and also then looking at the oil price and the activities that are required and necessary.”

Telford highlighted the particular risk faced by UK offshore workers, with many of them classified as essential workers due to the importance of oil and gas production in north-west Europe.

“What you've got is a collective of people from all areas of the UK, from the Shetland on the far north of Scotland right down to Brighton, and Cornwall, who are having to travel from their respective regions [and] they have to then go offshore and work together with people who have been excluded or may not be exposed,” she said.

“It's almost like a hotel offshore, or a cruise ship for example, they are perhaps a good example; but without thousands of people, you have anything from 40 to a couple of hundred people on a platform, but they're in a very confined space.”

There is also a structural issue at work here, that countries such as the UK and Norway simply have to keep producing oil, unlike bodies such as OPEC which can halt or advance production to carefully regulate supply and demand. Telford pointed to the “diversity of the corporate landscape in the UK” as a key contributor to this urgency to produce. 

The mishmash of different companies and operators, some very large and some very small, operating in the UKCS means that a single administrative body cannot impose a single policy to regulate oil production and supply, as no single policy would benefit all of these producers. 

So entrenched is the need to maintain production that operators on the UKCS are willing to keep working, even if they do so at a loss. A piece published by Westwood, and authored by Telford, noted that cost, comprised of operational expenses and planned capital expenditures, on the UKCS had reached over $15bn, and unless the oil price remains steady at above $27 per barrel, these operators will not be generating enough income to cover their costs.

Despite these challenges, Telford was optimistic about some aspects of the oil industry’s response, pointing to events such as the 2014 oil price crash, which saw the price of a barrel of oil tumble from $115 to $35 in just under two years, as helping the UK oil industry to prepare for future challenges.

“We had this initial culling of projects, but then what we saw, a year or two after that, was a real kind of business attitude at platform whereby the teams really worked at improving their operational expenses to barrel of oil equivalent costs,” she said, highlighting the industry’s renewed efforts on aligning operational expenses with the actual profits from selling a barrel of oil. Her report noted that 11% of forecast UK production for 2020 comes from assets with operating costs of under $20 per boe produced, compared to just 2% in Norway.

Yet this consideration does little to address the fundamental issue of a rigid industry having to adapt quickly. The very nature of private oil production, exemplified by the myriad range of companies operating in the UKCS, means that the vast majority of the industry cannot change course quickly enough to prevent much of the damage from a crisis like this, and even bodies with this nominal power are struggling to wield it effectively. OPEC is one such group, and Telford called on them and their allies to take on more active leadership roles.

“Collaboration between companies is always talked about and it's great in theory,” she said. “To collaborate on a global scale, I think OPEC and OPEC Plus [are] the groups who are well positioned to understand the negotiations required to agree production terms, to agree the production levels, to stabilise the oil price and, if reports over the weekend are to be believed, then we may see them getting back to the table sooner rather than later.

“It is critical that OPEC Plus can come to some agreement to stabilise the price because a $20 per barrel oil price does not help Russia, it does not help Saudi, so globally there needs to be some work.”

Bordered by Saudi Arabia, Kuwait, and the Persian Gulf, the Neutral Zone is a 2,230 square mile patch of land that was left undistributed after the Uqair Convention in 1922, which divided land between the two countries.

The region was largely ignored until the 1938 discovery of oil in the Burgan region of Kuwait excited the possibility of oil discovery in the Zone. By the mid-1960s, the two nations agreed to partition the area and exploit its reserves under a joint operating agreement.

That was until relations between the two countries disintegrated in 2015, after Kuwait accused Saudi Arabia of renewing Chevron Corp.'s Wafra oil field concession licence in the area without consultation. All production was subsequently halted.

Amidst a backdrop of rising oil prices, leaders of the two countries decided to put the dispute to bed last December, with both agreeing to restart production at Wafra and the offshore al-Khafji oil field, as well as to develop a large offshore gas field. 

At the time, oil ministers from both countries said the resumption of production would not impact their commitments to cuts agreed by OPEC. However, since then, the oil market, and indeed the entire global economy, has changed dramatically due to the ongoing Covid-19pandemic, putting the development in a very different context. 

The Saudi-Kuwait neutral zone was split between the two countries following the Uqair Convention.

Shortly after production in the Neutral Zone was shut down, the global oil price crashed, disincentivising the resumption of talks to end the disagreement. 

“At this point, both countries were looking more inwards, trying to make sure the domestic market was intact. There wasn’t enough catalyst in the market to reach an agreement because it was already over supplied with booming US shale,” explains Aditya Saraswat, senior analyst at Rystad Energy. 

In 2018-19 however, a stable oil price environment, rising from lows of $30 during the crash to hit $60-70 a barrel, coupled with an increase in demand, changed the mood. 

“They [Kuwait and Saudi Arabia] saw the additional oil [from the Neutral Zone] could be easily digested by the increasing global demand, making it the perfect market and price conditions to incentivize an agreement,” says Saraswat.

Furthermore, Ian Thom, principal analyst, Middle East upstream at Wood Mackenzie says, fundamentally, both sides will benefit from the restart. 

“It is likely that several factors were behind the partitioned zone agreement: for both Kuwait and Saudi Arabia it is much lower cost to restart the existing assets than to develop new resources. And there are also important gas resources that could only be developed after a political agreement was reached,” he says. 

After reaching the new agreement, in January Saudi Arabia and Kuwait issued contracts to study the development plan for the Dorra offshore gas field, which has an estimated 10-11 trillion cubic feet of gas and around 300 million barrels of oil. Development of the field was originally supposed to start in 2012 -2014.

The offshore project is particularly attractive to both countries. Saudi Arabia has ambitions to ramp up its expansion into natural gas as a key growth driver, while Kuwait is starting to import LNG as its domestic demand is rising. In January the country signed a 15-year agreement with state-run Qatar Petroleum for three million tonnes of LNG per year.

Rystad expects development of Dorra to start in 2024, with the field coming online in the second half of this decade

“It's a long journey because, while it’s a proven discovery, both countries have to jointly assess what sort of development requirement it needs for them to increase gas production from the field,” explains Saraswat.

While the development of Dorra is further down the line, production from the two oilfields, Wafra and the offshore al-Khafji, is expected to reach 550,000 b/d by the end of the year.

However, at the time of writing, global fuel demand has plunged by around 30% and benchmark crude is trading around $30 a barrel, half the level at the end of 2019. 

This is largely due to a fall in global demand as a result of Covid-19 lockdowns. The country has been locked into a dispute with fellow OPEC member Russia over further cuts to support prices. Saudi Arabia has been reducing its production and wants others to do the same. It’s expected that Russia and Saudi Arabia will soon agree to mutually cut production

There’s also speculation that Saudi Arabia wants to claw back some sway from the US shale producers as an active leader in balancing the oil market, which is also likely part of its motivation for restarting production in the Neutral Zone. 

The two oil fields in the zone, Wafra and Khafji, were collectively producing about 500,000 barrels or more per day before they were shut down. Now they are slowly starting back up again, producing 20,000-30,000 barrels per day, according to Saraswat.

Both nations were aiming for the fields to reach more than half of their full capacity by the end of this year, and full capacity by the end of next year. The International Energy Agency recently estimated that Saudi Arabia and Kuwait could potentially pump 320,000 b/d from the Neutral Zone a year.

“Now, however, everyone is trying to increase production after the fallout between Saudi and Russia, and so storage is getting full because demand has dropped; at some point, it will reach a peak,” says Saraswat.

“This is where the fields will hit a plateau of development because you can only produce how much you can transport and store; so then ramp up of the fields will be affected,” he adds. 

Rystad believes that instead of one-and-a-half to two-years to reach maximum capacity, it will be three to four years: around 2023/24.

“In the long term, we see prices getting balanced in 2023. On top of that, when there is enough appetite in the market, the initial assessment will be completed; then it would be well suited for the fields to increase production, which would give both Saudi Arabia and Kuwait enough share to book the export market,” says Saraswat.

Although the oil price crash will have a significant effect on the market overall, Saudi Arabia and Kuwait can manage with low prices for longer than other oil-dependent countries, says Thom.

“The Middle East is hugely advantaged relative to other oil and gas producing regions with its low-cost base,” he says. “But government revenues are heavily dependent on oil and gas, while their economies are characterised by extensive subsidies, limited personal taxation and a lack of diversification, but countries in the Middle East, such as Saudi Arabia, have large sovereign wealth funds or investments they can draw on.”

But certainly, Saraswat says, for the other oil projects in the Neutral Zone, the negative revision in global demand amid the coronavirus disease outbreak could adversely affect the development schedule and long-term oil production targets.  

“It will depend on when the global oil demand reinstates and oil price recovers,” he says. 

However, as both Kuwait and Saudi Arabia have ambitious LNG targets, the gas projects, such as Dorra, may bebetter suited to development.