Slide in oil prices signals a permanent market shift
The coronavirus pandemic has revealed the vulnerabilities of the U.S. oil and gas industry, and that specter cannot be exorcised.
Careful market watchers have always known that Saudi Arabia, Russia and the governmentowned oil companies in OPEC possess a silver bullet that can kill scrappy North American oil companies. OPEC and Russia have access to vast reserves at very low costs and can flood the market anytime.
Now that they’ve threatened to do that, the threat feels much more real. The numbers don’t add up for Texas producers to compete.
A barrel of oil from an existing well in Saudi Arabia has a marginal cost of $4, according to the number crunchers at Wood Mac, the financial data analysis company. In Russia, the shortrun marginal cost is $10.
Permian Basin shale oil requires $12 just to get it out of the ground, excluding the drilling and financing costs that are far beyond what OPEC and Russia pay. Based solely on operating costs, Texas oil ranks among the most expensive.
American oil executives have always assumed the cartel would keep oil prices high, and allow them to compete, due to what the petrostates call social costs. Saudi Arabia, for example, relies on oil revenue for 87 percent of its budget, and the government needs $88.60 a barrel to balance it, according to S&P Global Platt’s Analytics, which tracks energy markets.
The flood of North American oil, though, has kept prices from rising that high again. Saudi Arabia and other OPEC nations are waking up to the fact they must diversify their economies. In the meantime, they are selling assets and borrowing money. But for how long?
Saudi Crown Prince Moham
med bin Salman tried to convince Russian President Vladimir Putin to cut production and drive up prices. The problem with Texans is that when prices go up, we produce more oil and grab market share from Saudi and Russia.
Putin is tired of propping up American companies and refused to deal. The prince, known as MBS, decided to teach Putin and the Americans a lesson by promising to reclaim Saudi’s spot as the world’s largest producer.
The MBS-Putin tiff created too much supply as the coronavirus pandemic cratered oil demand. The result is $21-a-barrel oil for West Texas Intermediate, and $25 for Brent, the international benchmark, down from $60 a few months ago.
Prices below $30 barrel endanger every U.S. oil company, and even some of the majors, such as Houston-based Occidental Petroleum, which is struggling to avoid bankruptcy. All producers are slashing drilling plans, cutting salaries and laying off tens of thousands of workers.
The energy business activity index, produced by the Dallas Federal Reserve Bank, dropped to a historic low last month, signaling a “significant contraction” in the oil and gas business. The number of operating rigs is plummeting.
All this puts President Donald Trump in an awkward spot. He likes low gasoline prices for the American consumer, but his pledge to achieve “American Energy Dominance” requires OPEC and Russia to prop up prices.
Trump has reportedly been on the phone with
Putin and MBS, urging them to reach a deal. But even if they do, there remains the problem of reduced demand due to the new coronavirus.
The pandemic has caused oil consumption to drop more than 7 million barrels a day, and that oil is filling up storage. IHS Markit, a consulting firm that tracks these things, says storage will be full by summer if producers shut-in wells. This glut will likely suppress prices into 2022.
Investors who have already abandoned the oil and gas industry will not come back anytime soon. They have learned that MBS and Putin can pull the rug out from under U.S. producers anytime they want.
North American oil companies have been relying on a murderous dictator and a self-appointed czar to fix prices for their business plans to work. That is one heck of a business plan, and that’s before investors start to question how the coronavirus will permanently change consumption patterns.
When oil prices rose following the 2014 bust, I warned readers that not all the lost jobs would come back, nor would the market ever again sustain prices above $110 a barrel. Sadly, this latest bust may be another step down in the oil markets, bringing prices permanently lower.
What we’re witnessing now is more than routine volatility in the oil markets. These low prices signal a long-term, secular shift, and the dark presence of low prices will haunt the oil patch for a long time to come.
Tomlinson writes commentary about business, economics and policy. twitter.com/cltomlinson chris.tomlinson@chron.com