Collapse of oil prices should serve as a lesson for the state
Collapsing oil prices should vanquish any hope the Texas economy will recover from the COVID-19 crisis for years to come.
You can ignore Monday’s negative prices on the West Texas Intermediate futures market. As my friend Jim Krane at Rice University’s Baker Institute said, “the oil market’s trading algorithms have no way to express the deluge other than in prices run amok.” Negative pricing is silly.
But do look at international futures contracts further out.
The market expects prices to remain below $40 a barrel through December 2021. Most U.S. producers do not make money at less than $50.
Boosters like to brag about the Texas economy, but when economists study the so-called Texas Miracle, oil and natural gas made all the difference. If oil prices had not spiked in 2008 along with hydraulic fracturing’s commercialization, there would
have been no miracle.
Bill Gilmer, at the Institute of Regional Forecasting at the University of Houston, estimates half of the Greater Houston economy is affected by oil and natural gas. Typically, high prices fuel exploration companies on the west side, while low prices help refiners and petrochemicals on the east.
The recent collapse in prices, though, is from excess supply and disappearing demand. Exploration companies will need to lay off workers because we do not need more oil. Refiners will lay off because no one is buying their products.
The coronavirus recession is the worst of both worlds, and the crisis is far from over. In some ways, the economic damage to Texas only has just begun.
Saudi Arabia, other OPEC countries and Russia have promised to take 15 million barrels a day off the market. But oil demand has collapsed by 25 million barrels a day. That leaves enough surplus to fill five of the largest oil tankers every day.
The world does not have enough ships, and land-based tanks in the U.S. are filling up, which is why the Texas price is so low. But even on international markets, benchmark Brent crude is selling for about $20 a barrel, less than it costs to produce in most countries.
Crude keeps flowing because producers cannot quickly turn wells off. Safely stopping the flow can cost tens of thousands of dollars, and there is a good chance shutting one in will ruin it forever. Some oil companies would rather take financial losses than lose the well.
Smaller oil companies essentially are holding their hands over a flame in a contest to see who will pull back first. Many will not stop producing until creditors seize their assets, and even then, it’s cheaper to produce than to shut in a well before it runs dry due to sunk costs.
American shale wells are notoriously short-lived, but expiring wells will not solve the glut. The rest of the world has 20 million barrels a day of excess capacity, and most of that oil is cheaper to produce than shale oil.
OPEC and Russia will make sure they take as much market share as they want before allowing prices to rise to $50 a barrel, where shale can come back. Russia would prefer prices never get that high again.
President Donald Trump’s policy of U.S. energy dominance is partly to blame. He encouraged U.S. companies to pump oil into an already saturated market. On Tuesday, he promised to help industry workers, but he cannot change global market fundamentals.
The supply side of the equation offers no solace. Governments are beginning to ease the global economic shutdown, but consumers are reluctant to return to normal life while the virus remains prevalent.
People who can work from home, some of whom live with vulnerable family members, will not resume commuting anytime soon. Some companies will allow people to work from home at least several days a week forever.
Business air travel will take at least a year to return to normal, and tourism will struggle for even longer.
Energy also is tied to economic activity, and the latest forecasts do not predict a return to 2019 global gross domestic product levels until 2022.
Lastly, governments and businesses around the world will use this crisis to innovate and update. Much of the focus will be on more climate-friendly approaches. That means cutting fossil fuel consumption.
Texas is facing an economic depression due to its reliance on oil. Energy businesses should take this opportunity to reinvent themselves. If they took their genius and applied it to clean energy, they could become leaders in the field.
Trying to save the old business models, though, is a loser’s play. This crisis should be the shock that transforms the Texas economy forever.