April 11, 2020

How The Coronavirus Killed The Shale Industry

The answer to the question OPEC++ or a dead shale industry? is in.

The shale oil industry will die. I may come back in the future but that will be years from now.

The coronavirus pandemic has cut oil demand from 100 million barrels per day to some 75 Mbpd. Oil prices have fallen from $60 per barrel to $20/bl.

On Thursday OPEC+, the original oil producer cartel plus Russia, agreed formally to cut output by 10 million barrels per day. The real promised cuts would have been smaller. But the agreement depended on the commitment of all OPEC members.

Mexico did not agree to a cut. The country has hedged nearly all its oil exports:

Mexico, the world’s 12th-largest producer of oil, has hedged much of its 2020 output — that is, agreed ahead of time to a set price, reportedly about $49 a barrel. That practically eradicates any incentive Mexico might have to go along with production cuts this year.

At $1.3 billion the hedge was expensive for Mexico. But it guarantees that its budget for this year is fully covered. Mexico also redirected parts of its export to its own refineries to produce gasoline which it would otherwise have imported.

OPEC+ had also expected that other producers, the U.S., Canada, Brazil, would agree to cut their production by 5 Mbpd. Together with the 10 Mbpd from OPEC+ that would have helped to keep the oil price from sinking further. Yesterday a meeting of the G-20 countries was held to discuss the issue. None of them commited to hard cuts or quotas. Canada denied Russian assertions that it would cut 1 Mbpd. The U.S. rejected cutting more than what was already shut in for a lack of market. There will be no OPEC++.

Yesterday Trump talked again with Putin. He was told that there is no deal without Mexico and the other American producers committing to one. Trump then promised to somehow make up for Mexico:

By Friday afternoon, Trump was suggesting the U.S. falloff was sufficient to cover Mexico’s burden, as well — apparently without any sort of presidential order or quotas imposed by Washington.

It is questionable that OPEC+ will accept Trump's assertion as being equal to an official cut of Mexico's output. There is then no deal. While the OPEC countries will claim to stick to their official quotas to avoid U.S. pressure everyone will cheat and try to sell as much as possible.

Russia, Saudi Arabia and other Gulf countries may still cut some production. But the reason for that will not be Thursday's OPEC+ deal but a lack of demand and no room left to store surplus oil.

It means that the price of oil will move below $20/bl until demand comes back from its current 75 Mbpd to above 90 Mbpd. That can only happen when the coronavirus pandemic has ebbed, when the quarantines have ended and air traffic resumes at a sufficient rate. That point will probably come two years from now. But the effects of the global depression the pandemic will cause will take even longer to heal. When demand finally comes back to previous levels a rise in oil prices will still be much delayed because all storage is now full and must be sold off before more crude production can go back online.

U.S. shale oil was marginally profitable above $45/bl. That price is out of reach for the next to three to five years. That is much longer than the shale oil companies will be able to finance themselves. U.S. banks, which have loaned billions to those companies, are already getting ready to seize their assets. The banks will lose most of the $100+ billion they invested in shale companies.

Canada's expensive oil sand production is also unsustainable under the current prices.

The oil industries in North America had been free riding on the previous OPEC+ deals which limited production in countries which can produce at much lower costs. The artificially upheld prices have broken down and there is no way that they will come back any time soon.

This is a catastrophe for the labor market in the U.S. oil patch. Especially as the job losses will come on top of those in other services and industries.

It is also catastrophic for those Persian Gulf countries that depend on oil sales to finance their budgets. Iraq will be hit very hard and the lack of money may cause it to fall apart. The Saudi 'royals' will no longer be able to finance the welfare state that has held down any serious challenges to their ruling.

Alternative energy producer may also become a casualty of lower oil prices as they are no longer competitive. With low gasoline prices electric cars will lose their advantage of cheap electricity.

Trump had argued for a disengagement of the U.S. from the Middle East as the U.S. had achieved independence from foreign energy. With the shale oil industry on its death bed the U.S. will again have to import oil from the Middle East. While Trump's disengagement was never fully carried out the new situation may lead him to change his strategy.

Posted by b on April 11, 2020 at 18:36 UTC | Permalink

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