Unprecedented. This is the word first coming to mind when describing the situation that has unfolded in the wake of the current pandemic in all areas of life, including the economy. Unprecedented events send game-changing ripples across the economy, raising immediate questions about their near- and longer-term consequences. ‘We don’t know’ is neither a correct nor a constructive answer, especially in the case of companies in the process of expanding their asset base. As it is, responsible investors seeking to develop a business venture are driven by a vision of the future to which they aspire and which they are shaping. The more uncertain the future, the stronger the expectations that we present a vision of changes underlying our investment directions.
We are a group in the process of transformation. From an oil and gas operator, we are developing into a multi-utility business.
This development direction is aligned with a global mega-trend of energy transformation linked to digitisation, with electric transition at the end of that road. The world is becoming increasingly digital, and all digital is bound to eventually become electric. Electricity is a zero-emission form of usable energy. Emissions are generated in the process of its production from fossil sources, but their share in the global energy mix is declining in favour of renewables. The power of this mega-trend can be seen clearly in social preferences and the regulatory regimes, relating to both carbon dioxide reduction and investment financing. The transition to a low-carbon economy is a necessity, and technologies to achieve it are being developed at an exponential pace. The share of electricity in total secondary energy is on the rise, as it effectively enters the transport sector, where alongside hybrid vehicle drive trains (on-board power plant, mechanical power supply) and alternative fuels, it is dethroning oil. Hydrogen is an important fuel of the future, becoming part of the current transport ecosystem (fast refuelling points at service stations and long range) and of the energy system – where it is used to store surplus renewable energy. In the world towards which we are progressing, power generation holds a huge growth potential, which cannot be said of the traditional oil sector. This is not yet reflected in the market return on capital, but given the technology advances as well as the social and regulatory pressures, such shift is only a matter of time. It will be sealed by investor sentiment, especially of a long-term nature, turning slowly away from the oil and gas sector. Changes in business models and development of new technologies will be supported by capital inflows into companies respecting he Principles for Responsible Investing. This involves adherence to the ESG (Environmental, Social, Governance) criteria in the practice of business decision making.
Consequences of the COVID-19 pandemic will not affect the existing developmental challenges, which are underpinned by demographic processes, driving an increase in demand for energy, food and materials. Meeting these needs on a linear (open) basis leads to excessive consumption of natural resources, environmental degradation and a rise in greenhouse gas emissions at a pace posing a threat to further development. The world is trying to tackle these challenges, but so far without much success. The recession, coming as an aftermath of the lockdown of economies, has brought about a steep decline in greenhouse gas emissions, particularly of CO2 emitted by vehicles. In fact, this is the only benefit of measures introduced to contain the pandemic. Unfortunately, the economies cannot be kept frozen forever – we must produce to make a living. There are many signals that production levels will be significantly lower in the coming years relative to pre-pandemic projections, which entails a slower rate of emissions growth. Will this lessen the pressure on reducing emissions? Such scenario cannot be ruled out, but in our opinion intensity gains and efficiency improvements in these areas will be a priority for both the public sector (governments, supranational institutions and public organisations) and its private counterpart (mainly businesses and financial institutions). The pandemic period has witnessed an increase in government intervention and commitment of public funds in financial shields, designed to protect firms and jobs at risk. Does it make sense to channel public funds into projects intended to unlock old outstanding potential? Or would such funds be better allocated to initiatives speeding up the necessary transformation? There is much to indicate that the latter angle of thinking will prevail.
The relationship between primary production factors – labour and capital – will shift, triggering structural adjustments at the international (globalisation shape), national (development drivers) and sectoral (leading technologies) levels. For the first time in more than a century, the impending global economic crisis will have labour rather than capital as its root cause. Given the biological nature of the pandemic, its economic implications for different sectors will depend on whether they are more labour- or more capital-intensive. Therefore, long-term consequences of the COVID-19 crisis should be viewed by sector. The most affected sectors are those providing services that involve direct human contact, such as air travel, public transport, mass events, cinemas, theatres and galleries. In the energy sector, the knock-on effects of transport restrictions have taken their toll on the refining industry and crude oil production. Restrictions on physical contact between people have not affected the utilities sector. The decline in electricity consumption reflects a decrease in manufacturing output. Social distancing, which mitigates the risk of a new pandemic wave and the emergence of new ones, will prompt an adjustment or change in business models across all sectors of the economy, creating new relations between the capital and labour inputs. Changing consumer behaviours will make demand for transport services recover at a slower pace, with a concurrent shift in its structure (public vs private transport, car and ride sharing vs vehicles for personal use). Changes in consumer behaviours due to the pandemic will have no adverse impact on utilities. An analysis of the potential after-effects of the pandemic should best be carried out at the level of economic and industrial sectors. But before we proceed to such analysis, let us first take a look at the global economic impacts.
According to the spring economic forecasts by the European Commission, released on May 6th 2020, most EU countries are likely to see two-digit GDP declines in the second quarter of 2020. The deepest declines will be felt by France (-18.4%), Italy (-18.2%) and Spain (-17.5%). Germany’s economy was shrink by -11.8%, while Poland’s will recede by -4.5%. The EU-wide GDP will fall by -14.2%, and the US recession will reach -12.9%. Throughout 2020, the global economy is likely to contract by -3.5%, relative to the previously forecast growth of 3.0%. In the EU, a recession of -7.4% will set in instead of the previously predicted 1.4% economic growth. France’s economy will shrink by -8.2% (instead of the 1.3% increase), Italy’s – by -9.5% (vs the expected growth of 0.4%), Spain’s – by -9.4% (instead of the 1.5% growth), and Germany’s – by -6.5% (vs the previously forecast growth of 1.0%). Against this background, Poland’s recession will be relatively mild (-4.3% vs the forecast increase of 3.3%).
'The COVID-19 pandemic’s toll on economic activity in recent months is only the beginning of the story. While the rapid and unprecedented collapse of production, trade, and employment may be reversed as the pandemic eases, historical data suggest that long-term economic consequences could persist for a generation or more.'
(https://www.imf.org/external/pubs/ft/fandd/2020/06/long-term-economic-impact-of-pandemics-jorda.htm)
The upstream and refining sector will remain under the pressure of damaged demand for crude oil and liquid fuels, as well as the accelerated peak demand date:
On the supply side, excess production and refining capacities will persist, putting pressure on both prices and margins.
Global excess of refining capacities will prompt the sector to consolidate. The consolidation pressure will be felt strongly in Europe.
Investment appetite for oil and gas companies will be drying up:
Worldwide growth in demand for petrochemicals set to outpace GDP, giving a strong edge to refineries integrated with petrochemical assets.
Power generation will experience a progressive shift towards renewable sources and its wide use (including in transport) will give it a value advantage over the traditional fuel segment.
Retail continues to offer a number of opportunities:
Innovation, Research and Development
Adam B. Czyżewski Ph.D.
Chief Economist, PKN ORLEN
June 2020