[Editor's note: A version of this story appears in the April 2020 edition of Oil and Gas Investor. Subscribe to the magazine here.]
One analyst dubbed it “OPEC-aggedon.” Another a crash of historic proportions. Others: disaster; and, low-cost producer deathmatch. A Raymond James March 9 report summed it up: “When it rains, it pours.”
The U.S. oil and gas sector was already struggling through a protracted capital starvation period and tepid commodity prices, but black swan events cannot be predicted, only responded to. When the three-year Saudi Arabia-Russia production-cut marriage ended acrimoniously on March 6, with each not only disagreeing on new cuts, but threatening to ramp up production to spite the other, the oil and gas world as we know it ended. For now.
The WTI price plummeted to near $30/ bbl. That’s a drop from $45 the week before the OPEC-plus-Russia meeting and as high as $63 in January. The last time we saw oil prices this low was in February 2016, at $26. Here we go again.
The breakup between the Saudis and Ruskies shouldn’t be a surprise. They sit on opposite sides of the political aisle regarding Syria and Iran and were only in this shotgun matrimony to prop up global oil prices. We should have thanked them for these years of relatively stable prices, but we didn’t. We grabbed their lost market share as long as we could. It was bound to end.
At the tail end of a beginning-of-year earnings season in which U.S. independents promised disciplined capex with measured growth and certainly free cash flow, that all blew up. Now—suddenly—it’s all about survival. Precious few plays are economic at $35 oil. So, assuming this price shock has staying power, that raises the question: What actions must you take to survive?
A handful of producers responded proactively right out of the gate. Parsley Energy Inc. immediately dropped two frac crews and three rigs. Marathon Oil Corp. trimmed its 2020 budget by 20%, including all drilling and completion activity in Oklahoma and some in the Delaware Basin. Diamondback Energy Inc. slashed three completion crews and two rigs. San Andres conventional player Ring Energy Inc. suspended all activity to concentrate on liquidity preservation. Even King Occidental Petroleum Corp. haircut capex by 32% and slashed its precious dividend by a let’s-get-serious-now 85%.
More—a lot more—are sure to follow. Because as much as we hope that OPEC and Russia will hug and say “psych” by the end of March when the existing production cut agreement ends, that’s unlikely, said Morgan Stanley global oil strategist and head of European energy research Martijn Rats, in a conference call March 9. “It still looks a little frosty,” he surmised.
Rats noted that it took a year to put the OPEC+ partnership together, and once the genie is out of the bottle, putting it back in again “is nigh impossible in the short run.”
Russia exited the ill-fated meeting by taking all production limits off of its producers, and Saudi Arabia responded by promising to hike output by 2.6 MMbbl/d, to 13 MM- bbl/d. This threatened supply war rages in the face of a worldwide coronavirus-induced demand slump.
“Oil markets are now facing an unprecedented double shock … that will likely push crude prices to multidecade lows,” said IHS Markit vice president of financial services Roger Diwan, in a report released shortly after the price drop. Multidecade lows? How low?
“Markets are now facing a supply battle amid a demand crisis. The last time this occurred was in 1998 during the Asian financial crisis, when Venezuela’s aggressive production growth triggered a price war and pushed oil prices into the single digits. … U.S. E&Ps will very much be at the receiving end of a price collapse.”
While less-than $10 oil sounds alarmist, no one seems to think this tiff between the oil-producing big daddies will be a passing blip, including Diwan. “It’s not ‘if’ (crude) stocks will build significantly, it’s by how much,” he said. How much fortitude do they have to willingly flood the markets? If the overbuild is “manageably oversupplied,” the markets will take one to two quarters to unwind, he said. If “catastrophically oversupplied,” then buckle in for four to six quarters.
The negative impact of the price war is clearly unfolding in the U.S. On the Morgan Stanley call, Rystad Energy’s Artem Abramov said he expects U.S. shale capex to drop in 2020 to $76 billion from $105 billion as guided in earnings calls. If prices hang in the $30s through this year, capex could drop to $45 billion next year.
“Thirty-five dollars just does not work for activity going forward. We’ll see significant declines in production from the U.S. if the price environment doesn’t improve.”
Perhaps this will prove a bad dream by the time you read this, but the prognosis is for a protracted battle royale. If so, it could be a hard landing.
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