US, WASHINGTON (ORDO NEWS) — “Believe me, it will be a sad day.”
This statement by the Minister of Energy of Saudi Arabia, Prince Abdel-Aziz bin Salman, made on “black Friday” on March 6 at the OPEC + meeting, turned out to be true, as world energy giants enter the oil war, which caused a price collapse and raised concerns about the possibility of bankruptcy of the entire American shale industry.
If America’s energy independence is in jeopardy, can the country’s oil and gas industry survive the effects of this crisis?
“There is no plan “B”
After holding back supplies since 2017, in order to maintain prices at the crucial meeting in Vienna, the OPEC oil cartel tried to achieve an additional reduction in production by 1.5 million barrels per day (b / s), starting in April.
It was assumed that the main members of OPEC will reduce production by one million b / s, and countries that are not members of OPEC, primarily Russia – by 500 thousand b / s.
Even before the start of negotiations, oil demand had already begun to fall due to the global coronavirus pandemic and off-season warm January. Iranian Oil Minister Bijan Zanganeh said that in the event that Russia or other countries outside the OPEC do not accept this proposal, OPEC “has no plan B”.
However, according to available information, Russia refused to participate in this on the grounds that as a result of a further reduction in production, an even larger market share will be transferred to American manufacturers.
In response, Saudi Arabia decided to flood the oil market by increasing production. She plans to increase production by 25% to 12.3 million bpd in April, starting a price war in an attempt to regain lost market share.
This oil-dependent Middle East kingdom lowered its April sales prices, putting pressure on Russia and other non-OPEC producers, including the United States. Saudi Arabia’s neighbors also warned of increased production – including a million barrels per day in the United Arab Emirates.
Russia responded by saying that it could increase production to 500 thousand bpd and bring volumes to a record 11.8 million barrels after the OPEC + agreement expires on April 1st.
Market reaction was instant. On March 18, already low oil prices fell by more than half, reaching an 18-year low and amounted to just over $ 20 per barrel. For almost a decade, prices had been around $ 100 per barrel, and for almost five years, oil was trading at more than $ 50.
According to forecasts of the financial conglomerate Morgan Stanley, in the second quarter of 2020, Brent crude oil will be trading at around $ 30 per barrel, while other analysts warn that if the confrontation between Saudi Arabia and Russia continues, the price may fall below 10 dollars per barrel.
Oil is now under a “triple blow” because prices are determined by three main factors — the price war, the COVID-19 coronavirus pandemic, and the market glut. And all this happens just when the state of the world economy is at the lowest level since the global financial crisis. The pandemic is expected to reduce fuel demand worldwide by at least 10%, but the situation may worsen depending on the degree of the global crisis.
At the same time, a market glut in the first half of this year can range from 800 million to 1.3 billion barrels, which IHS Markit consulting company calls “the most extreme glut of the world oil market in history”.
“There has never been a global surplus of this magnitude,” said Jim Burkhard, vice president and head of the oil market department at London-based consulting company.
“Prior to this, the world’s largest semi-annual surplus in this century was 360 million barrels. What awaits us will double this figure or more.”
On March 24, West Texas Intermediate (WTI) was trading at around $ 24 a barrel, while Brent futures were trading at $ 27 a barrel against Washington’s $ 2 trillion fiscal stimulus to support a staggering US economics.
However, analysts are not sure that the decline process will be stopped.
“It is likely that further stabilization of oil prices will be impossible.”
US Shale Industry Impact
The shale boom has led America to become the world’s largest producer of crude oil in 2018, exceeding the output of Saudi Arabia and Russia. After the previous US oil deficit of $ 436 billion in 2008, US producers saw a surplus in September 2019, with the result that President Donald Trump announced earlier this year that “we don’t need Middle Eastern oil.”
Even the collapse of prices in 2014-2016, which led to the fact that dozens of American oil and gas companies declared themselves bankrupt, and the dismissal of hundreds of thousands of workers could not weaken the growth dynamics of American industry.
Will it be different this time?
According to estimates by Wood Mackenzie, an international consulting company operating in the fuel and energy sector, many companies will only need the average price of Brent oil to be $ 53 per barrel to break even. If, by the end of 2020, Brent oil prices average $ 35, the loss will be about $ 380 billion.
“This time, after five years of rational investment and austerity, it will be necessary to reduce the much less obvious excess costs. And raising capital is now much more difficult, especially for independent US companies, and activity in the M&A market is at a record low, ”said Tom Ellacott of Wood Mackenzie.
“In addition, many companies have already made the bulk of their sales of apparent assets.”
According to analysts at the S&P Global Platts news agency, given that companies are cutting production, jobs and investments to stay afloat, this year the American industry will receive less than 500 thousand barrels per day and will increase volumes to 1.3 million barrels per day in 2021.
If prices begin to rise again, rebuilding American industry will be more difficult due to high debt levels.
“The fact that we are not seeing a recovery in the US shale industry at the same pace as it was in the cycle of low oil prices in 2015-2016 is partly due to the state of financial institutions and their willingness to refinance the US shale industry,” said the director of international analytical Department of PS & Global Platts, Chris Midgley.
“Debt maturing in 2021 and 2022 ($ 20 and $ 30 billion, respectively) will have to be refinanced, and at such prices it will be very difficult.”
According to Dave Ernsberger, head of pricing and market analysis at PS & Global Platts, the lack of investor support could be disastrous.
“The entire shale sector over the past two years has been under intense pressure from investors demanding a positive cash flow, dividends and return to shareholders. Any company that stated that it would overspend and significantly increase production was subjected to “punishment”, losing on a decrease in the value of assets, ”he said.
“Now, after what has happened over the past couple of weeks, it’s almost impossible to imagine that any highly profitable company will be able to refinance anything in an unsecured or secured market … Bond prices have fallen, yields are off scale, they are trading at 20% -21 %, so we are waiting for general failure to fulfill obligations and bankruptcy. ”
According to the law firm Haynes & Boone, operating in the fuel and energy sector, a record number of bankruptcies and a decrease in the speed of assets were recorded last year: 50 energy companies (including 33 oil and gas producers) filed for bankruptcy, and even more such cases are expected in 2020, given the approaching wave of arrears.
This industry is also in a difficult position as a result of a decrease in well productivity as shale regions mature. According to experts of HPM Markit, the annual decline in production from wells at the Permian Basin shale field is about 40%, and an increase in the scale of drilling is required to restore volumes, which is unlikely, however, it is expected that the number of drilling rigs will decrease by 30%.
Although American oil companies have managed to reduce drilling costs by about $ 20 per barrel over the past five years, only 16 of them work in fields where the cost of drilling new wells is less than $ 35. According to the Federal Reserve Bank of Dallas, the break-even price for the industry is $ 50 per barrel, and this year most of them put in the budget prices of about $ 55-65 per barrel.
“When trying to find ways to improve efficiency, never rely on technology — you will need it … but serious upheavals are expected in the next year and a half,” said Midgly from ES&P Global Platts.
Will Russia or Saudi Arabia retreat? According to the estimates of PS & Global Platts, the break-even price for Russia is $ 54 per barrel, and for Saudi Arabia – $ 82, which means that in the event of a prolonged price war, both countries have something to lose.
However, Russia has accumulated gold and foreign exchange reserves, which are estimated at $ 520 billion, and Saudi Arabia has the lowest cost of oil, along with gold and foreign exchange reserves of about $ 500 billion and a small government debt. Saudi Aramco, the national oil company, is known for having a production cost of one barrel of about $ 2.80, while Russian companies, including Rosneft and Gazprom, report production costs of less than four dollars.
“Both Russia and Saudi Arabia can wait a long time and will soon begin to feel real economic damage,” Midgli concluded. According to the analyst, “in the foreseeable future” the price war will continue (unless market conditions worsen), and most likely, to the detriment of American industry.
However, low prices threaten Saudi Arabia’s plans to diversify its economy, and lower government spending may cause dissatisfaction among the repressive regimes in all Gulf countries, as well as in Russia and Venezuela.
According to estimates of the International Monetary Fund, even if oil prices return to the level of $ 50-55 per barrel, by 2024, the gold and foreign exchange reserves of Saudi Arabia will decrease to the level of five-month import coverage, which will lead to a potential crisis of the balance of payments and the failure to peg to the dollar.
America is taking steps back, and the Trump administration has announced plans to purchase up to 77 million barrels of crude oil and appoints Victoria Coates as special energy representative in Saudi Arabia amid speculation about a deal between the U.S. and Saudi Arabia to stabilize oil markets. Some U.S. lawmakers called for an embargo on oil purchases abroad, and the Texas Railroad Commission even proposed limiting production in Texas to support prices.
President Trump said America is still able to “have a significant impact on the situation” and can still find a compromise. The American leader will need all his famous ability to conclude deals and even more to realize what could become the deal of the century with Saudi Arabia in order to maintain energy independence and the shale industry of the United States.
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