[Editor's note: A version of this story appears in the May 2020 edition of Oil and Gas Investor. Subscribe to the magazine here.]
Welcome to Thunderdome, raggedy man. Turns out the oilpocalypse isn’t a brutal fight to fuel up Mad Max’s V8 Interceptor. In this twisted reality, there’s plenty of crude. Just no toilet paper.
Adding to our new surreal existence, the COVID-19 pandemic has sidelined professional sports and forced the cancelation of the Scripps National Spelling Bee, leaving ESPN to air a spelling bee rerun. (Spoiler alert: a kid won.)
Other things in short supply: M&A, capital and common sense.
Transactions activity, which was already muted to begin the year, went into radio silence as the pandemic and the oil price war sent oil tumbling to its lowest level in 21 years. Enverus said in April that deals will likely restart in earnest after crude prices stabilize.
That future price is likely to be low. Asset packages on the market have already fallen to about $5 billion in expected value, Enverus said. And with debt maturity dates ticking closer, the industry’s next great flood may be distressed assets.
Some have celebrated the OPEC+ deal to cut production by nearly 10 million barrels a day to end a resoundingly dumb price war. Chief combatants Saudi Arabia and Russia decided to play chicken without realizing they, too, were in the pot. Still, credit and all-around kudos to OPEC+, which prevailed in forcing itself to agree to its own terms of surrender.
Many people are noting that President Donald J. Trump said on Twitter that he was involved in the OPEC+ negotiations “to put it mildly.”
With the pandemic still rampaging worldwide, however, the oil and gas industry remains at the mercy of the virus. As one Twitter user noted in April, demand destruction may be a solid name for a rock band, but by every other measure it’s uniformly awful.
Paul Sankey, managing director at Mizuho Securities USA LLC, wrote in a commentary that the demand destruction “is so dramatic that supply management is moot for the month of April. … This overhang will take years to work off. The OPEC meeting gave you that answer, setting cuts through April 2022.”
But Ann-Louise Hittle, vice president of Macro Oils at Wood Mackenzie, said that even if the OPEC+ deal is poorly implemented, it would still make a substantial difference in the market.
“We expect the second half of 2020 to show an implied stock draw, in contrast to the record-breaking oversupply of the first half of 2020,” Hittle said. “That will support and lift prices significantly. The market will recognize this once the storage builds slow this quarter and start drawing down in the second half.”
Will it be enough? Goldman Sachs analyst Damien Courvalin said in an April report he doubted so. Despite a rally in prices after the OPEC+ agreement, WTI could sink back to $20/bbl.
“Ultimately, the size of the demand shock is simply too large for a coordinated supply cut, setting the stage for a severe rebalancing,” he said.
Roger Diwan, vice president of financial services at IHS Markit, likewise said the supply cuts resolve the price war (for now) and spare the U.S. from a “catastrophic price scenario” that would have wiped out many E&Ps.
“But this improved scenario will not change the fact that the production decline unfolding in the United States will be in the same range as the forced shut-ins or cuts agreed [to] by Russia and Saudi Arabia,” Diwan said in a April 13 report.
Regional benchmarks and wellhead prices will continue to show further discounts and are likely to force shut-ins above and beyond the supply agreement, Diwan said. Declining production of 3.7 million barrels per day in the U.S., Canada and other producers reflect these “distressed economics.”
In the here and now, energy companies’ default risk is rising. As of April 13, the energy sector’s default rate was 9.9% following the bankruptcy of Whiting Petroleum Corp., according to Fitch Ratings. The default rate could reach 17% by year-end.
E&Ps on Fitch’s watch list collectively hold $18.3 billion in debt, and most have upcoming interest payments in the next 60 days. Chesapeake Energy Corp., California Resources Corp., Denbury Resources Inc., Unit Corp. and Bruin E&P Partners are among companies facing potential defaults.
Diwan, speaking about the differentials between global benchmarks and physical prices, said the disparity speaks to “dual reality of hope and despair.”
This may well be a year of reckoning for the industry. But to paraphrase Winston Churchill, never flinch, never weary, never despair. Or as Max would put it, “survive.”