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The latest energy news: rolling back output cuts, price of carbon heats up, Americans hit the road

Earnings season is imminent — and it’s not going to be pretty. Every sector will suffer, but none more than energy.

Second-quarter numbers will paint the most extensive picture yet of the carnage wreaked by the coronavirus pandemic. Revenues will tumble, profits will tank and writedowns will be commonplace. Bosses will urge investors to look forward not back.

Energy Source will be surveying the damage as it is reported, but today we heed those pleas and look at the road ahead for the sector at large.

Our first item looks at Opec’s plans to roll back output cuts and what lies ahead for US shale. Our second is about how hopes for a green recovery are driving up the price of carbon. Elsewhere in ES today: Americans are back on the roads. And what next in the Dakota Access Pipeline drama?

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Has Opec+ already won the market share battle?

Global oil supply is about to rise. Provided it can keep a lid on crude prices, Opec+ should get the lion’s share of the increase.

The cartel’s oil output reduction of 9.7m barrels a day from May to July has, in tandem with rising demand, tightened the market. But the International Energy Agency and others now predict a deficit in the second half of the year, meaning output can begin to return to pre-crash levels.

Tomorrow, Opec+’s Joint Ministerial Monitoring Committee is likely to endorse a long-planned supply increase from August of 2m b/d. Saudi Arabia is keen to stick with the schedule, according to three people familiar with its position.

Meanwhile US suppliers appear ready as ever (see graphic) to compete for a share of any supply increase. The price crash sent American output tumbling from 13m b/d to a low of 10m early last month, according to Genscape, a division of Wood Mackenzie. But a rally to $40 a barrel has allowed production to bounce back to around 11m b/d as some wells have restarted.

More supply is coming. Florian Thaler, chief executive of OilX, which monitors daily global oil flows, told Energy Source that US output would surge by at least 600,000 b/d this month. The IEA predicts it will keep rising gently through the end of the year.

Will it? The numbers of operating rigs and fracking crews in the shale patch continue to fall, so the US output rise isn’t led by drilling. It’s because at $40 a barrel — WTI’s price over recent weeks — operators think they can profitably restart the wells they shut earlier.

But to keep shale production steady, you need to keep drilling and completing wells — that’s the sector’s distinctive cast-iron rule. Without a swift pick-up in activity, supply could drop by 300,000 to 400,000 b/d per month, according to analysts.

The big operators will drill just enough to maintain new output and keep the decline rates at bay. But more profit, not more production, is the priority over the next 18 months. That was the message from Matt Gallagher, Parsley Energy’s chief executive, in an interview with the FT this week. “We don’t need to be growing, even if there’s a price signal.”

US production would not recover this year’s highs in his lifetime, the Parsley chief said. And while some “offshoot companies” might “adopt the growth stance” again if prices rose, “it’s not going to affect the world supply-demand dynamic”.

Have the Saudis, who helped push the oil price off the cliff in March, won? “Yes,” said Mr Gallagher in an email exchange after our interview.

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The curious case of the soaring carbon credit

If anyone tells you they know of a one-way bet it’s generally a good idea to nod sagely then check your wallet is still in place.

But it’s not clear this is widely understood in the European carbon market.

The EU Emissions Trading Scheme, or EU ETS, has soared in the last few months, with traders looking beyond the market’s frankly dreadful short-term fundamentals to focus on the bigger picture: that the EU wants a green recovery and therefore will need carbon prices to rise.

On Monday morning, prices jumped 5 per cent to get above 30 euros a tonne — the highest in 14 years — and came within just a few cents of hitting the all-time record of 31 euros a tonne from 2006.

Prices have more than doubled since March, despite actual emissions being widely expected to fall sharply this year — reducing demand for allowances — as economies slow in the face of the coronavirus pandemic.

So what is going on? Well, some fingers have been pointed at speculators and hedge funds, but not everyone is convinced.

Trevor Sikorski at Energy Aspects highlights that the latest Mifid positioning report suggests that more than 10 times as many new long positions came from commercial and compliance buyers in the second quarter — broadly industrial end users and utilities — as opposed to investment funds.

“The causes of strong trend rallies are often identified as being speculative, particularly if moves are not well supported by fundamentals,” Mr Sikorski said. “[But] while proprietary sources are potentially playing a role, exchange data are far from convincing.”

Instead, utilities have been happy to buy as they believe they can see what is coming: that the EU will at some stage reduce the number of allowances further to help support the price as part of a broader push to lower emissions.

“Most participants have not had to sell, with sector hardships being lessened by government stimulus loans and/or recourse to repo trades,” Mr Sikorski said. “Instead, the data suggest that they have seen the current period as an opportunity to buy, given the expected future shorts.”

But does that mean the market has become a one-way bet? With the EU effectively controlling how many allowances to release in the future, it’s starting to sound a little like it. That’s almost certainly reason for caution.

Americans are going to work again: overwhelmingly by car — and not by public transport. An aversion to crowds, and the ensuing risk of coronavirus transmission, is keeping them off metros and buses, Apple mobility data suggest. Instead, the inhabitants of New York, Chicago, Los Angeles and Houston are back behind the wheel in numbers exceeding pre-crisis levels.

Even in California and Texas, where fresh coronavirus surges have prompted a reimposition of restrictions, car travel has recovered completely.

PwC, Deloitte, EY and KPMG had higher number of audits needing big improvements, FRC finds

The UK’s biggest accounting firms have been criticised by the industry’s watchdog for an “unacceptable” decline in the quality of their work after a third of their audits fell below its expected standard.

The Financial Reporting Council said a higher number of audits needed significant improvements at each of the Big Four firms — PwC, Deloitte, EY and KPMG — as well as the smaller firms BDO and Grant Thornton.

Its sharpest criticism was reserved for PwC, the UK’s largest audit firm by revenue, as well as KPMG and Grant Thornton. The firms are being investigated by the regulator for their involvement in high-profile corporate failures at Thomas Cook, Carillion and Patisserie Valerie.

“We are concerned that firms are still not consistently achieving the necessary level of audit quality,” said David Rule, the FRC’s executive director of supervision. “The tone from the top at the firms needs to support a culture of challenge and to back auditors making tough decisions.”

The watchdog’s latest annual review is based on a sample of audits carried out by the UK firms.

The findings come as the Big Four firms prepare to separate their audit practices from their wider consulting, restructuring and tax divisions over the next four years under plans to improve audit quality by the FRC. The profession has been subjected to intense scrutiny for poor working practices and conflicts of interest after a series of accounting scandals.

The FRC said it was particularly dissatisfied with the firms’ record of standing up to the management of their clients, which it said meant auditors were failing to challenge companies, particularly on the impairment of goodwill, revenue and contracts and loan loss provisions. It said the firms were also conducting poor work when judging going concern — a company’s ability to continue trading for the next 12 months — as well as monitoring inventories, group oversight and investment property valuations.

“Firms’ senior management need to be clear that taking difficult decisions is an appropriate response to improving audit quality, even if it might sometimes mean delaying or modifying opinions, and ultimately losing some audit engagements,” the FRC warned.

The regulator said Grant Thornton’s audit quality inspection results were “unacceptable”, adding to pressure on the sixth-largest accounting firm, which it accused of “very poor audit quality” last year. The FRC found that 45 per cent of its audits required improvements and that it was particularly bad at auditing revenue and ensuring the appropriate levels of challenge and scepticism.

Grant Thornton said: “Audit quality remains a priority for us, and we are encouraged by the indicative progress we have made over the past year in enhancing our audit quality.”

The FRC said PwC’s and KPMG’s inspection results were “unsatisfactory” and the firms would be subjected to greater scrutiny. It found that 35 per cent of PwC’s audits and 39 per cent of KPMG’s audits required improvements. That was a steep decline from 23 per cent and 24 per cent respectively last year.

KPMG audit head Jon Holt said: “We believe audit quality is improving year on year and we will not be happy until we consistently achieve AQR scores which reflect that progress.”

Meanwhile, the FRC found that 24 per cent of Deloitte’s audits required improvements and 29 per cent of EY’s.

“We are disappointed our overall results are not higher and we have plans in place to address the FRC’s feedback,” said Andrew Walton, head of audit at EY. The FRC ordered EY — which is facing international pressure over its audits of NMC Health and Wirecard — to improve “firm-wide procedures” such as strengthening the culture of challenge within its audit processes.

About 38 per cent of BDO’s audits required improvements, the FRC said, and 20 per cent of Mazars’ audits. Both firms have been rapidly growing their audit practices and winning larger, more complex audits over the past two years.

Record weekly outflow from ETF known as ‘TQQQ’ suggests wariness after momentous rally

An exchange traded fund designed to amplify the moves of red-hot US tech stocks has just suffered its worst ever week of outflows, suggesting that investors are growing wary of highly stretched valuations.

Investors pulled $491m from the ProShares UltraPro QQQ ETF last week in the biggest weekly withdrawal since the ETF launched a decade ago, according to data from Bloomberg.

The ETF is a risky investment, aiming to use leverage to deliver three times the daily performance of the Nasdaq 100 stock index — a benchmark of the biggest companies listed on the tech-heavy market.

The outflows failed to make much of an impression on the fund’s assets, which closed the week at a record $7.1bn, propelled by a strong performance for stocks including Apple, Amazon, Alphabet and Tesla. The fund’s holdings are up about two-thirds in value from the start of the year, roughly three times the return of the benchmark.

But the redemptions from the UltraPro QQQ fund — the largest leveraged ETF — could be a sign that investors are easing out of tech stocks after a momentous rally, said Ben Johnson, head of ETF research for Morningstar.

The tech-focused benchmark includes mega-cap stocks that have acted as haven assets during the Covid-19 crisis and represent more than a fifth of the US stock market — the highest proportion on record.

“We’ve seen quite a run in the Nasdaq 100 in recent months and it’s likely time for many to consider locking in the gains,” he said.

On Monday tech stocks were the hardest hit in a rapid afternoon sell-off after California rolled back most of its economic reopening measures to contain the pandemic. Such an announcement would typically trigger a shift toward tech stocks, “but in this case they felt the biggest pain — I found that telling,” said Jim Tierney, chief investment officer of US concentrated growth at AllianceBernstein. “Maybe people are saying they’ve run pretty far and maybe investors are taking some profits.” 

The Nasdaq 100 is up 21.4 per cent for the year, compared with a 2.3 per cent loss for the S&P 500. The price-to-earnings ratio, a popular yardstick of valuation, has also widened between the two indices. Investors are paying 33 times the trailing year’s profits for companies in the Nasdaq 100 compared with 21 times for stocks in the S&P 500 — a gap that has nearly doubled since the start of the year, and is at its widest since December 2007.

“It’s very much about price-to-earnings multiple expansion rather than earnings growth,” said Mr Tierney.

The year’s best performer in the Nasdaq 100 is Zoom, the video conferencing group that has become a market favourite after a surge in use of its product during lockdowns. The stock has nearly tripled in value. Tesla, the second-best performer, is up more than 250 per cent for the year.

ETFs that use borrowed money to magnify returns have drawn criticism in the past. Carl Icahn, the billionaire investor, has repeatedly taken aim at such instruments over the years, saying they have helped turn the stock market into a “casino on steroids”.

A “short” version of the ProShares Ultra QQQ ETF — designed to deliver three times the inverse daily performance of the Nasdaq 100 — had $261m of inflows over the week, the most in more than three months.

“This category of funds is not intended to serve investors with a long-term orientation,” said Mr Johnson of Morningstar. “It’s about capitalising on short-term moves in the market.”

Commission measure likely to attract fierce opposition from smaller EU countries

Brussels is planning to pursue low-tax member states over their advantageous corporate tax regimes as pressure mounts on EU policymakers to crack down on sweetheart tax deals in the wake of the Covid-19 crisis. 

In what would amount to an unprecedented legal assault, the European Commission is exploring ways to trigger an unused treaty instrument to reduce multinationals’ ability to exploit highly advantageous corporate tax schemes.

Crucially, unlike ordinary tax legislation in the EU, the initiative would only require the backing of a qualified majority of the EU’s 27 member states rather than unanimous support of all countries, restricting a government’s ability to wield a veto. The measure would also need approval from the European parliament. 

Tax avoidance by multinationals has shot up the political agenda in the wake of the pandemic as governments around the world spend billions to kick-start their economies. The commission has also promised to revive its plans for an EU digital services tax on big technology companies after the US pulled out of international negotiations last month. 

Officials told the Financial Times that the plans, under Article 116 of the EU’s treaty, were at a very early stage but would aim to identify certain competitive national tax schemes as distortions of the single market. They are likely to trigger intense controversy among member states, which fiercely protect their taxation powers.

It is a key week for Brussels’ pursuit of multinational tax avoidance. On Wednesday, the General Court, the EU’s second-highest court, will decide whether the commission was correct to order Apple to pay €13bn in back-taxes to the Irish government in 2016.

Were that decision to be struck down by judges, there would be significant implications for the commission’s ability to pursue multinationals. “If the commission loses the Apple case then it is running out of tools to go after aggressive tax planning,” said one official.

Brussels has in the past made numerous attempts to clamp down on aggressive tax planning schemes, but the moves have been traditionally vetoed by countries with more favourable tax rules. “This could be the key to unblocking the impasse we’ve had so far,” said a southern European diplomat.

Another diplomat said the commission was taking its time preparing the highly sensitive measure as Brussels needed guarantees that it would not be struck down by a blocking minority of governments. The commission declined to comment.

Article 116 of the EU treaty gives Brussels the powers to correct “distortions” in the single market, but has never been used. The instrument allows the commission to propose a directive designed to correct distorting tax schemes and sue governments at the European Court of Justice if they do not comply.

The measure is likely to target schemes in countries such as the Netherlands, Luxembourg, Belgium and Ireland, said one official. Diplomats expect the plans to be fiercely resisted by some member states, opening up the prospect of years of lengthy legal battles at the ECJ.

Paul Tang, a Dutch MEP and incoming head of the European parliament’s subcommittee on tax, said: “Bringing Article 116 into play could stop unfair practices in EU tax havens. It is a race to the bottom which benefits a small few at the expense of the rest. This is unacceptable, especially in difficult economic times.”

How the pandemic transformed the travel industry. An imagined scenario from May 2022

In september 2019 a group of climate activists formulated a plan to shut down London Heathrow, Europe’s largest airport. Heathrow Pause, a splinter group of the Extinction Rebellion movement, had been inspired by an incident at Gatwick the previous year, when an unauthorised drone closed Britain’s second-largest hub for three days. They hoped to repeat the trick at Heathrow. But their drones failed to get off the ground, due to signal-jamming by the airport. In December 2019, Extinction Rebellion tried again to close Heathrow, this time by blocking its entrance road with a pink bulldozer. But police confined the protest to a single lane of traffic, meaning that incoming passengers could simply drive around the problem.

The activists lying in front of the bulldozer that cold December morning could not have known that a virus just 0.1 microns wide, more than 8,000km away in China, was inadvertently about to help their cause. Few industries were harder hit by the subsequent covid-19 pandemic than air travel. Government lockdowns, travel restrictions and cancellations by fearful passengers soon grounded most of the industry. By April 2020 Heathrow’s passenger numbers had fallen by 97% to the lowest monthly figure since the 1950s. Global passenger numbers did little better, falling that month by 94% year on year, to levels last seen in 1978. Half a year of lost revenue later—amounting to well over $250bn—the industry’s finances were in ruins.

Two years on, the forecast made in May 2020 by the International Air Transport Association (iata) that passenger numbers would return to pre-pandemic levels by 2023 now looks wildly optimistic. But the trade body’s prediction that only 30 of the world’s 700 or so airlines would survive the crisis without government help was spot on. Carriers that failed to get bail-outs fell like dominoes, starting with Flybe, Europe’s largest regional airline, in March 2020, Virgin Australia in April and latam, Latin America’s largest carrier, in May. Sir Richard Branson, founder of the Virgin Group, became an illustration of his old quip: “The easiest way to become a millionaire is to start out as a billionaire and then go into the airline business.”

Even airlines that got government bail-outs did not find life easy. Austria and France led the way by imposing strict environmental conditions. Airlines were forced to cut their emissions to meet aggressive targets and to end competition against greener alternatives such as high-speed rail. That raised their costs and limited their potential revenue. And they were soon cash-strapped again. America’s airlines quickly chewed through $25bn in federal grants and loans; Air France-klm and Lufthansa of Germany did the same with bail-outs worth nearly €10bn ($11bn) each. The result was a drastic slimming down of the world’s flag-carriers.

Airline executives had initially thought the pandemic would cause manageable, but not catastrophic, disruption. Looking at previous epidemics in Asia, such as sars in 2002-03 and the South Korean outbreak of mers in 2015, iata expected a sharp dip in traffic, followed by a return to the original trend six or seven months later. In retrospect, that was overly hopeful. A short, stuttering recovery during the autumn of 2020 was choked off by the pandemic’s second wave of infections. “This time is very different,” says Leigh Bochicchio of the Association of Corporate Travel Executives, an American industry association. “It’s a very different beast to sars or 9/11.” After those earlier shocks, there was no second wave of infections or terror attacks to remind people of the danger of flying.

And in retrospect, sars was much easier for airlines to manage than covid-19. sars showed symptoms immediately and could be detected with temperature checks at airports. It was not initially contagious; those infected could be isolated before they spread it to others. Covid-19, in contrast, shows no symptoms for up to two weeks after infection, a period in which it is contagious. No wonder experts soon found that airline travel was the primary means by which the disease spread around the world.

In the past, the airline industry has always fully recovered from crises. But this time has been different. “Peak plane”, once Extinction Rebellion’s fantasy, no longer looks so inconceivable. With the prospects for a vaccine still uncertain, business travel began to pick up again in 2021, though only as a trickle. The biggest global downturn since the Depression left corporate travel budgets an easy cost-code to squeeze.

Even firms that are solvent enough to let their employees fly have not been keen to do so. “People are more comfortable with online meetings, and that will never go away,” notes Ms Bochicchio. After the global financial crisis of 2007-09, international business travel fell by a third in many countries, and never recovered. Companies found new ways of doing business using video calls. That story repeated itself in spades after covid-19. Many corporate events and conferences have gone online permanently. Another chilling effect was that firms feared being sued by employees who caught covid-19 on business trips—a possibility their insurers increasingly refused to cover. As a result, the average age of business travellers is now falling: surveys show millennials are more likely to regard business travel as a status symbol than older workers, and consider themselves at less risk from covid-19.

Leisure travel has been much slower to recover. That was not due to any initial reluctance to get back in the sky. Surveys during the pandemic found that 69% of Americans said they missed travelling. Half of Chinese expected to travel more once the crisis was over. Perhaps most remarkably of all, 23% of Britons said they planned to be on the first flight deemed safe.

But many newly established “air bridges” and “travel bubbles”—pairs and groups of countries between which travellers could move without quarantine—collapsed in panic when the second wave of the pandemic hit in autumn 2020. “Staycations”—holidaying within one’s own country—became the norm in 2021, as crowded aeroplane cabins were shunned in favour of cars, trains and even cruise ships (which, despite their association with the early weeks of the outbreak, turn out to be well suited to social distancing).

The aviation industry did its best to win back customers with a marketing blitz, but cabin crew dressed in personal protective equipment, who treated all passengers as biohazards, failed to reassure. The requirement to leave middle seats empty, to maintain social distancing, was dropped by governments when airlines complained that it cut their capacity. But that prompted concerns that airlines were more concerned with profits than with passenger safety.

The end of low-cost flights

Rising ticket prices have also deterred travellers from flying away on holiday. Although fares initially fell to put bums back on seats after the first and second waves—dropping by 35% in 2021, just as Dollar Flight Club, an American travel website, had predicted—the low prices didn’t last long. Ryanair, Wizz Air and Air Asia, the world’s biggest budget carriers after the pandemic, waged the “mother of all fare wars” in an effort to put all non-state-subsidised rivals out of business in Europe and Asia. The resulting consolidation has left little competition in the industry. As soon as they could, airlines began to pass on the extra cost of their new counter-coronavirus measures to passengers. Analysts think fares could soon be double what they were before the pandemic.

Perhaps the clearest sign of the long-term change in direction for aviation has been the collapse in demand for new aircraft. The world’s two biggest planemakers, Airbus and Boeing, predicted just before the pandemic that global air travel would grow by 4.3% each year over the next 20 years, requiring around 40,000 new airliners to be built. Now they are not so sure. Airlines permanently grounded over 5,000 planes during the pandemic. Boeing cut future production by 50% and cancelled plans to develop two new airliners in the coming decade. Even Airbus, which has enough orders to keep its assembly lines busy for a decade, decided to slow production by 30%.

The biggest casualties were the biggest birds. Boeing 747 jumbos, once the “Queens of the Skies”, were nearly all grounded in 2020, never to fly again. The even-larger superjumbo fared almost as badly. “The a380 is over,” lamented Sir Tim Clark of Emirates during the pandemic. Having once owned 115 of the 242 in existence, Emirates retired 40% of them in 2020.

Planemakers and airlines alike are pinning hopes of a travel revival on the wanderlust of the young, and of the rising middle classes in the developing world. Their faith may be misplaced. The young are highly climate-conscious and have taken to “train-bragging”, encouraged by campaigners such as Greta Thunberg. Several European governments have stepped up investment in high-speed rail as part of their stimulus packages. Polls suggest people under 25 see climate change and pollution as the two most important issues facing the world. In the developing world, meanwhile, the pandemic shattered the illusion in Africa and India that travelling by plane was any safer or more hygienic than overcrowded diesel trains or by car.

That covid-19 has exposed the fragility of globalisation is particularly apparent in the case of aviation. The industry can no longer rely on the steady growth of the past, or indeed any growth at all. Yet historians will write that it was not radical environmental movements such as Extinction Rebellion that killed the trend. Instead it was the combination of a microscopic virus and free-market capitalism.

The five-year period before the pandemic was the only one since Orville and Wilbur Wright made their first flight in 1903 in which the industry covered its cost of capital. Burned again by covid-19, many investors have now decided to stay away from anything that flies. Warren Buffett, a billionaire investor, once quipped that “if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favour by shooting Orville down.” During the pandemic, Mr Buffett realised that this historical observation was no joke. Selling his shares in American airlines at a multi-billion dollar loss, he noted that they should be avoided by investors. His reason: “The world has changed after covid-19.” ■

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