Cyprus Mail 10 September 2020
by Dr. Charles Ellinas
The Covid-19 pandemic brought havoc to oil supply and demand, and to global oil markets and prices. With the global economy grinding to a halt, this led to an unprecedented 16.4million barrels/day (mb/d) drop in global oil demand during the second quarter of 2020, causing a dramatic collapse in the oil price. OPEC+ and other major producers reacted swiftly by implementing equally unprecedented cuts in oil production, reaching close to 14mb/d in April, from a peak production of about 100mb/d at the start of the year.
But currently, with global economic activity slowly recovering, oil demand is also on the way up, albeit at a slow rate. The International Energy Agency (IEA) expects that global oil demand will decline by 7,9mb/d in 2020 and to recover by 5,3mb/d in 2021, still 2,6mb/d below 2019 levels.
The Brent oil price has now recovered from the lows it reached in April – down to less than $20/barrel – hovering within a range between $40-45/barrel since end of May. But uncertainties associated with the increasing Covid-19 cases and the risk of further lockdowns are preventing further recovery.
However, with OPEC+ still committed to a cut in oil production of 7,7mb/d to the end of the year, the oil price is likely to remain stable, but low.
Nevertheless, the IEA confirms that the worst of oil demand decline is now behind us, but warns that the risk to the oil market outlook will remain as long as Covid-19 continues to disrupt recovery of global economic activity.
Prominent among oil price forecasts in the period to 2024 are those provided by Fitch Solutions and Bloomberg.
Fitch Solutions expects Brent to average $41/barrel this year, increasing to an average of $45/barrel in 2021, $50/barrel in 2022, $53/in 2023, remaining at $53/barrel in 2024. But Fitch says that should lockdowns become more widespread and prolonged, these prices could end up being 10%-20% lower.
Bloomberg is more optimistic, forecasting that Brent will average $42,4/barrel in 2020, $50/barrel in 2021, $53/barrel in 2022, $55/barrel in 2023 and $60,4/barrel in 2024.
Clearly, both expect a gradual recovery, but by the end of 2024 Brent crude will still be well below the average price of $64,4/barrel reached in 2019 and $71,3/barrel in 2018.
What it could mean for the price of electricity
So what would this mean for the price of electricity in Cyprus, that in 2018 was over 90% dependent on oil products – diesel and heavy-fuel-oil. In order to understand that, lets look at Cyprus Electricity Authority’s (EAC) cost make-up. In 2018, the last year for which there are published accounts, fuel accounted for 63 per cent of costs, operational costs for 31 per cent and profit was about 6 per cent. Oil products comprised 83 per cent of the fuel cost, with 17 per cent spent on the purchase of renewable electricity and greenhouse-gas emission allowances.
Interestingly, this cost make-up compares with other electricity producers, but with EAC having higher operational costs. In 2018 the Public Power Corporation of Greece (PPC) spending was 68 per cent on fuel, 27 per cent on operational costs, with 5 per cent profit. EDF in the UK did better, with 66 per cent on fuel and 25 per cent on operational costs and 9 per cent profit. There is room for improvement, but evidently EAC fares reasonably against other similar companies.
As a result of the abnormal impact of the pandemic on the economy and the consumption of electricity, it is not possible to infer what would be a reasonable price for electricity in 2020. In addition, the regulator, CERA, decided that, due to the impact from the pandemic, EAC should lower its tariff by 10% during the lockdown period, extended later by a further four months.
However, with the oil price in 2021 expected to be about 63 per cent of its 2018 average – based on Fitch’s base-case – EAC’s oil product fuel costs should experience a similar drop. Assuming that electricity consumption and operational costs remain the same, but that the cost of purchasing of renewable electricity and greenhouse-gas emission allowances doubles in comparison to 2018, would lead to close to a 10 per cent reduction in the price of electricity in 2021. According to Eurostat, the 2018 household electricity price in Cyprus was €0,22/kWh. As a result, the 2021 price should be about €0,20/kWh.
But with the cost of oil products and the cost of purchasing of renewable electricity and greenhouse-gas emission allowances rising, any benefits will disappear after 2021.
However, there is hope. Presenting CERA’s annual report to President Anastasiades early September, CERA chairman Andreas Poullikkas said “We expect healthy competition in this sector by the end of 2021”, presumably through increased adoption of renewables.
In addition, according to DEFA, the LNG import terminal is expected to be completed in 2021. DEFA says that the substitution of oil products in power generation by gas will cut consumer costs by up to 25 per cent.
Should these developments deliver as indicated, their combined impact could be substantial cuts in Cyprus’ electricity prices by 2022, well in excess of 25 per cent.
The other beneficiaries of low oil prices will be motorists, who over the next few years should be profiting from low petrol prices.
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