Oil Boom Reaches Sudden End
Concerns over the spread of the coronavirus and its dampening effects on global crude demand combined with the irrational actions of Saudi Arabia and Russia in early March caused crude prices to crater. With analysts like Goldman Sachs, along with the U.S. Energy Information Agency (EIA) and the U.N.’s International Energy Agency (IEA) now predicting that overall demand for crude oil will actually contract during 2020, the lower price situation is likely to linger at least into 2021.
This in all likelihood means that the shale oil boom that began in mid-2016, creating the largest-ever increase in American oil production and turning the United States into the world’s largest producer, is over—at least for now. Our oil boom reaches a sudden end.The big question becomes: What happens next?
I’m old enough to have seen this all before. In fact, during the course of my 40-plus years in and around the oil business, I’ve seen booms and busts come and go so many times that I’ve lost count. A very good friend in the business was fond of saying that the only thing you can count on in the oil business was that the industry would always, without fail, drill itself out of prosperity, and that is exactly what has happened here when you get right down to it.
For more than two years now, it has been obvious that the rapid growth of U.S. oil production could only be sustained by the continuation of the OPEC+ agreement by the world’s other large oil-producing countries to limit exports. The more oil barrels that U.S. producers poured onto the market, the deeper the OPEC+ countries would have to cut in order to sustain a price high enough to make ongoing shale drilling profitable.
But U.S. upstream companies, urged on by pressure by investors and market conditions, just continued to drill more and more wells, relying on often-irrational actors like Russia and Saudi Arabia to continue acting rationally, cutting ever-deeper into their own production volumes in order to support the price.
This is the behavior my friend was talking about, of course.
Crude prices had already dropped below healthy levels even before Russian and Saudi Arabian leaders took their irrational actions around the OPEC+ meeting in early March. Concerns over containing the coronavirus had by then caused the Chinese economy to basically flatline, leading IHS Markit to project that oil demand during the first quarter of 2020 would be more than 5 million barrels per day less than during Q1 2019. Enough impacts had already been felt that, by the time Russia told the OPEC+ meeting that it would not support another proposed 1.5 million barrels of oil per day cut in exports, the price for a barrel of West Texas Intermediate had already dropped to $46, well below the break-even price for many shale wells.
Russia’s announcement came on Friday, March 6, and WTI dropped to $41 per barrel. When the Saudis announced their plan to dramatically increase their own production in retaliation to Russia’s actions the next day, the price collapsed to $31 on Monday, March 9. As I write this piece a few days later, no one knows whether the Saudis and Russians will play at this game for a long period of time. It is known at this time, though, that the price impacts from the demand-destroying effects of the coronavirus will very likely linger throughout the remainder of 2020, making a return to a WTI price above $50 per barrel a dim prospect.
There is much speculation at the time of this writing that Moscow and Saudi Arabia believe they can “kill” America’s shale industry by collapsing oil prices.
But we know that the Saudis have already tried to kill the U.S. shale business once before when they intentionally flooded the market with crude and caused prices to drop into the low $20s. Their belief then was that they could cause hundreds of U.S. producers to go out of business, taking millions of barrels of U.S. production per day off the market entirely.
That, of course, betrays a complete misunderstanding of how the free U.S. market works, and of the nature of American bankruptcy laws. While the crash in oil prices that began in late 2014 did ultimately result in hundreds of shale producers declaring Chapter 11 bankruptcy, the net result of that process is that most of those companies reorganized themselves and came back with far less debt load. The strategy also fails to recognize that most producers have already put hedges in place for most of their equity production through the remainder of 2020 and beyond.
As a result of these realities, from the time the Saudis embarked on their strategy to reclaim market share in mid-2014 through August 2017, when they initiated talks with Russia related to the OPEC+ agreement, overall U.S. production actually rose by half a million barrels per day. That increase in production came during a period of time in which more than 200 upstream companies went through the bankruptcy process.
So, if Moscow’s and Riyadh’s plan here really is to try to “kill” the U.S. shale industry, they had better be prepared – and able – to sustain it for a long and painful haul. For Russia, whose economy is highly dependent on oil income, many analysts question whether that country could sustain the impacts of $30 oil for even a year. Saudi Arabia is in a much better financial condition, but the royal family there burned through about 40% of its sovereign wealth fund the last time they tried this, in their efforts to sustain their country’s array of social programs.
By the time this is published, it is possible that the actions by the Saudis and Russians will have been resolved and the OPEC+ agreement renewed. But the price impacts from the coronavirus will linger throughout the remainder of 2020.
One thing we know for sure is that all the major players in every country involved in this situation have been through all of this before and, if they remain involved in this cyclical industry for another 5-7 years, they will most likely go through it all again.
Because the only truly predictable thing about the oil and gas business is that the industry will ultimately drill itself out of prosperity, and that’s essentially what has happened yet again.
Oil Boom Reaches Sudden End – About the author: David Blackmon is the Editor of SHALE Oil & Gas Business Magazine. He previously spent 37 years in the oil and natural gas industry in a variety of roles — the last 22 years engaging in public policy issues at the state and national levels. Contact David Blackmon at [email protected]