What’s next for oil? 3 questions answered

Source: By Mike Lee, E&E News reporter • Posted: Tuesday, May 26, 2020

Oil prices started to recover last week after the coronavirus pandemic fueled a historic drop in both demand and production.

But even with the shift, the oil industry remains in a historic downturn, and there’s uncertainty about how and when — or even whether — a recovery will happen. The pandemic, which has killed more than 340,000 people globally and more than 98,000 in the U.S., forced governments to severely restrict travel and business activity.

Before the outbreak, West Texas Intermediate crude, which sets the price for most U.S. production, was selling for more than $60 a barrel at the beginning of the year. It briefly sold for negative numbers in April. Even after last week’s recovery it cost around $33 a barrel.

That’s below the break-even price for most U.S. companies, particularly shale drillers, according to a survey by the Federal Reserve Bank of Dallas in March of more than 90 oil producers. Prices have to be between $23 and $36 a barrel just to cover the expenses of an existing well, the survey said. And it takes an average price of $46 a barrel to profitably drill new wells, the survey said.

The number of drilling rigs looking for oil fell to 237 on Friday, the lowest point since 2009, according to Baker Hughes Co. The number of oil and gas rigs combined has hit a new record low each of the last three weeks — landing at 318 on Friday.

Statistics on U.S. oil production typically lag by a month or two, but North Dakota’s top energy regulator estimated his state’s output has fallen by a third since March (Energywire, May 18).

The reaction has been fast. Tens of thousands of workers have been laid off as companies shut down drilling and curtailed their production.

The downturn is spreading into the natural gas market, too. Deliveries to liquefied natural gas plants, which ship U.S. gas oversees, have fallen by more than one-third, from 9.5 billion cubic feet a day in March to 6 billion cubic feet a day this month, according to the consulting firm IHS Markit.

“The inevitable has happened,” IHS Markit Executive Director Terrell Benke said in a research note last week.

As the novel coronavirus pandemic heads into the summer months, here’s three questions answered on what’s next for oil.

What factors will shape the recovery?

Oil production in the U.S. will gradually return in June, and prices could rise as high as $40 a barrel by the end of the year, Mike Bradley, a managing director at the investment bank Tudor Pickering Holt & Co., said on a webcast with other analysts last week. But there’s a catch.

“That is really contingent on demand,” he said.

The news about oil demand is a mixed bag. China’s fuel consumption has almost returned to its pre-pandemic level, Bloomberg News reported last week, citing unnamed sources.

In the U.S., most states are encouraging businesses to reopen, but unemployment hit another record last week. And that’s cutting into demand for fuel in the biggest oil-consuming country.

The number of passengers passing through airport security checks fell to 318,000 on Friday, down from 2.7 million on May 17, 2019, according to the Transportation Security Administration.

Last year, 43 million Americans traveled over the Memorial Day weekend, the unofficial start of the summer vacation season, according to AAA. This year, the nonprofit travel service declined to give an estimate, saying the pandemic had undermined the economic data it uses.

“With social distancing guidelines still in practice, this holiday weekend’s travel volume is likely to set a record low,” Paula Twidale, senior vice president of AAA Travel.

There are wild cards, too. Facebook CEO Mark Zuckerberg said last week that as many as half the company’s roughly 45,000 employees could work from home within a few years, according to the Associated Press. If that practice is widely adopted, it could cut into gasoline consumption and cause ripple effects at restaurants, dry cleaners and other businesses that rely on office workers.

And, analysts said, a resurgence of COVID-19 cases could change the outlook for the worse and any news about a successful treatment or vaccine could change the outlook for the better.

Can the government help?

Early in the crisis, the Trump administration discussed directly intervening to help oil companies. Energy Secretary Dan Brouillette said his department was ready to buy oil and store it in the Strategic Petroleum Reserve to help support prices.

But the administration largely backed away from that approach and came under pressure from the American Petroleum Institute and other interest groups who favor allowing the free market to force companies to cut production.

Likewise, the president has declined to impose tariffs on imported oil, an approach being pushed by Republican Sens. Kevin Cramer of North Dakota and Jim Inhofe of Oklahoma.

State energy regulations have largely stayed out of the picture, too. The Railroad Commission of Texas, which oversees oil and gas production, held a hearing on the idea of mandatory production cuts to help stabilize prices but rejected the idea.

Oklahoma and North Dakota have also held hearings on so-called prorationing but have not made final decisions. The Oklahoma Corporation Commission passed a separate proposal that’s intended to work like a force majeure clause, allowing companies to shut in oil wells without violating their leases or other agreements.

The hands-off approach is better in the long run, said Bryan Riley, an economist and director of the Free Trade Initiative at the National Taxpayers Union Foundation.

“It’s always dangerous when the government gets involved because there are always unintended consequences,” he said in an interview.

What will the post-pandemic industry look like?

There will likely be structural changes in the oil industry as weaker companies are forced out of the business, analysts at the data firm Rystad Energy said on a webcast last week.

“Bankruptcy auctions will be coming — and I think the pencils are sharp,” Jai Singh, an analyst at the firm, said on the webcast.

National oil companies — the government-owned firms like Saudi Arabian Oil Co. and China National Petroleum Corp. — are expected to cut their exploration budgets by about a fourth this year, the equivalent of a $5 billion drop in spending, according to the consulting firm Wood Mackenzie.

Like the slowdowns among U.S. producers, that will have a long-term impact, too.

“Exploration budget cuts, while necessary today, will impact companies’ future growth and sustainability,” Wood Mackenzie senior analyst Huong Tra Ho said.

Big investors may also opt to pull their funds out of the oil and gas sector. BlackRock Inc., the world’s largest money manager, announced this year that it’s refocusing its nearly $7 trillion in investments to help address climate change.

The trend could accelerate, David Solomon, the CEO of the investment bank Goldman Sachs Group Inc., said in an interview with IHS Markit last week. Goldman and other banks are trying to improve the sustainability of society in several ways, including access to health care and preventing climate change.

“We are going to see capital allocation change with respect to energy to try to find ways to have a greener future,” he said.