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The Oil Industry's 2021 Outlook Looks Bleak

By Matthew DiLallo – Sep 19, 2020 at 10:20AM

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The demand recovery seems to have stalled out.

The oil industry entered 2020 with the wind seemingly at its back. Crude oil prices were in the $60s, fueled by the view that demand growth was on track to accelerate. That outlook had many oil producers planning to drill more wells so that they could capture higher prices.

However, like a punch to the gut, the COVID-19 outbreak knocked the wind completely out of the oil industry earlier this year as government restrictions on business and travel pushed demand off a cliff. While consumption has improved from the initial collapse, it's not rebounding as fast as many forecasters previously expected. The sector faces a long road to recovery.

An oil pump at dusk.

Image source: Getty Images.

So much for the rebound

Heading into 2020, most oil market forecasters expected continued growth in oil demand. For example, in the International Energy Agency's (IEA) January oil market report, it foresaw another 1.2 million barrel per day increase in global oil demand for the year, which was on top of last year's 1.1 million BPD growth. 

However, the COVID-19 outbreak shattered the industry's growth expectations. The IEA now only expects worldwide oil demand to average 91.7 million BPD this year, a stunning 8.4 million BPD year-over-year decline. Further, that projection was 300,000 BPD below its view last month. Meanwhile, OPEC also recently cut its 2020 demand expectations, chopping 400,000 BPD off its initial projection to arrive at a final figure of 90.2 million BPD.

Unfortunately, neither group is optimistic about what lies ahead for next year. In its most recent market report, the IEA wrote that "the path ahead is treacherous amid surging COVID-19 cases in many parts of the world." Because of that, its outlook for oil demand has grown "even more fragile." It further commented: "The economic slowdown will take months to reverse completely, while certain sectors such as aviation are unlikely to return to their pre-pandemic levels of consumption even next year."

Meanwhile, OPEC warned that risks remain "elevated and skewed to the downside" for oil consumption next year. That led the group to revise its 2021 outlook downward by 400,000 BPD, too. As a result, it now expects global oil demand to average 96.9 million BPD next year. While that would be a 6.6% year-over-year improvement from 2020's forecast level, it's well below 2019's peak.

What these forecasts mean for oil stocks

The increasingly tepid outlook for oil demand next year is not what oil companies wanted to see since most had hoped that consumption would bounce back sharply in 2021. That anticipated improvement would bolster oil prices, giving them the cash flow to jump-start their drilling programs.

However, with demand not expected to rebound quite as much as expected next year, oil companies will likely need to rethink their strategies. Instead of restarting production growth engines, they'll need to transition more to a maintenance mode in which they only drill enough new wells to replace the production declines of legacy ones.

Because of that, they're likely going to run substantially fewer drilling rigs over the coming year. For example, Parsley Energy (PE) set its initial 2020 budget to run on $50 oil, which would have given it enough cash to operate 15 drilling rigs on its acreage position. However, with crude prices currently below $40 a barrel, growth is off the table, especially given the current demand forecasts. As a result, Parsley and its peers will likely focus on stabilizing production, which, in its case, will only require four to five drilling rigs. 

With demand for drilling rigs unlikely to rebound in the coming months, market conditions for oil field service contractors will go from bad to worse as their existing contracts expire. That's evident in the forecast of drilling contractor Patterson-UTI Energy (PTEN -3.34%). After running 82 rigs for its customers during the turbulent second quarter, the company sees that count falling to 59 during the third quarter. Meanwhile, Patterson-UTI Energy only has contracts covering an average of 38 rigs for the coming quarters. Because of that, its revenue and margins will likely continue to fall.

Given the expectations that market conditions won't improve all that much in the coming quarters, more financially troubled oil companies will probably go bankrupt. Meanwhile, stronger ones will need to pursue consolidation since the sector's growth prospects have seemingly evaporated.

A tough road ahead

This year has been brutal for the oil industry as demand cratered because of COVID-19. That caused oil prices to plummet, unleashing a shockwave that forced several oil companies to file for bankruptcy. Unfortunately, market conditions aren't improving as fast as industry forecasters had hoped, suggesting the sector is in for a tough slog. Because of that, more companies will likely go bankrupt. Those that survive will need to consider merging with a rival in hopes that their increased scale will enable them to better weather the storm that seems ahead for the sector.

Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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