HOUSTON – The American oil industry may have dodged a bullet.
Russia and Saudi Arabia – which only a month ago hoped to cut American producers – have withdrawn from threats to pump more oil into the already saturated market. Acknowledging that the bet was also hurting, they announced last week that they had tentatively agreed to cut production.
The change of course would give American companies the possibility of gradually reducing production on their own terms, without any government or regulatory mandate, since they invest much less in exploration and production.
“I hope the US oil industry has avoided the worst-case scenario,” said energy and Middle East expert Amy Myers Jaffe at the Council on Foreign Relations. “There will always be bankruptcies, but for now, fears of massive destruction of the industry can now be put aside, because the worst of the price war has passed.”
What has happened in recent days could support an industry that directly and indirectly employs nearly 10 million Americans. The sharp increase in US production in recent years has reduced dependence on foreign oil and lowered prices at the pump for consumers.
Uncertainties remain for the industry. Thursday and Friday, the virtual summits of the oil-producing countries and the Group of 20 energy ministers ended with some ambiguity, when Mexico backed away from an agreement drawn up by Russia and Saudi Arabia to reduce collectively producing 10 million barrels per day. But the two oil powers appeared ready to give Mexico a pass after President Trump made a vague promise that the United States would make the cuts that its neighbor to the south refused to make.
Members of the Organization of the Petroleum Exporting Countries led by Saudi Arabia had started talks in the hope that the United States, Canada and other western producers would accept explicit reductions, which would represent 4 to 5 million more barrels per day. Instead, US officials have just guaranteed that crude oil production will be reduced over time, in addition to the voluntary reductions that have already started in some American companies.
The global oil industry still has many problems. The collapse in economic activity caused by the coronavirus has reduced demand by about 30 to 35 million barrels a day, according to international energy agencies and oil consultants.
Analysts expect oil prices, which climbed above $ 100 a barrel just six years ago, to remain below $ 40 for the foreseeable future. The benchmark price for US oil was just under $ 23 a barrel on Thursday.
But a total freefall in single-digit oil prices – something we haven’t seen in two decades – seems to have been avoided. President Trump’s recent public lobbying in Russia and Saudi Arabia to cut production has helped raise prices by several dollars a barrel, allowing many U.S. companies to reduce their exposure to lower prices by covering themselves. By fixing their selling prices at a higher level closer to the break-even point of shale wells, they were able to limit their losses.
US oil companies are already cutting thousands of jobs, plugging old wells and decommissioning platforms and fracturing equipment in anticipation of the worst downturn in more than a generation. Oil-producing states such as Texas, Oklahoma and North Dakota expect heavy job losses and tax revenues.
Falling demand for oil around the world could lead to an almost complete drying up of US oil exports, which reached more than 3 million barrels a day last year. Concerns about climate change will continue to fuel the industry and scare investors.
But industry leaders predict consolidation, in which small, indebted companies are either bought by larger companies or merged. Declines in production will occur based on supply and demand market conditions. US oil production has already fallen by several thousand barrels a day in the past two months and will likely drop another 2 million barrels a day until the end of the year, according to the Department of Energy.
“Some companies will not survive,” said Trent Latshaw, president of Latshaw Drilling, an oil services company operating in Texas and Oklahoma. “But the industry in general will survive and come out stronger. We will have to make difficult decisions, innovate and we will become smarter because of this. “
The scenario is similar to the last time that Saudi Arabia and its OPEC allies flooded the oil market in 2014 in an attempt to undermine American shale producers who were taking market share away from them. Prices plummeted and hundreds of American companies went bankrupt and 170,000 jobs were lost. While US production fell briefly, it quickly recovered and increased.
The coronavirus is a new, bigger challenge for the industry, and that challenge was briefly magnified when last month Russia refused to join Saudi Arabia to cut supplies. Russian oil leaders have grown tired of losing market share to American producers. Saudi Arabia responded by promising to pour more oil into the market, bringing prices to around $ 20 a barrel for a while, less than half the level at the start of the year.
Saudi Arabia’s decision to put an additional 3 million barrels a day on the market was a huge gamble that backfired, and it is possible that oil prices will fall further in the coming days if traders are not satisfied with the reductions announced by Saudi Arabia, Russia and its alliance partners. In fact, on Thursday, the last day of trading in oil futures, the price fell sharply, even though producers were close to a deal.
Behind all the cogs and windy deals, Saudi Arabia has managed to bring Russia back into the fold of an alliance of producers called OPEP +. But caught off guard by the magnitude of the falling prices, Saudi Arabia and Russia had to reverse the trend and cut supply to support crude prices.
“There have been miscalculations on both sides,” said Ben Cahill, a senior energy researcher at the Center for Strategic and International Studies. “The Russians miscalculated the severity of the Saudi response and they might have been surprised by the magnitude of the drop in prices.”
“Saudi Arabia will have big budget deficits, it will have to issue a lot more debt, it will have to run out of reserves, and the more this cycle continues, the more it will be destructive,” said Cahill. .
With the pandemic crushing economies around the world, few buyers were available in recent weeks to buy cheap Saudi crude. The kingdom stored oil in Egypt and was forced to leave unsold crude oil in tankers along its coasts.
The growing glut has become a threat to the finances of the Saudi government. At an expected average price of $ 34 a barrel this year, estimated Norwegian consultant Rystad Energy, the kingdom’s revenues would be 50% lower than in 2019, a loss of $ 105 billion.
Saudi Arabia still has foreign exchange reserves of $ 500 billion, but these increased from $ 740 billion in 2013. Several years of falling oil prices forced the kingdom to borrow money and reduce energy subsidies for its citizens. Crown Prince Mohammed bin Salman is now counting on his reserves to help diversify the Saudi economy for the future.
Russia is in much better financial shape than Saudi Arabia, especially with a flexible exchange rate – as the ruble depreciates, the value of its exports increases. If it would also lose billions of dollars in revenue from falling oil prices, the government has a much smaller budget deficit than Saudi Arabia and has $ 550 billion in foreign exchange reserves.
But Russia has other responsibilities. It has limited processing capacity and its refineries have insufficient storage facilities. It relies on long pipelines to transport its oil to European and Asian buyers. But European demand has collapsed and Russia’s storage tanks are filling up quickly. China is still buying oil at unbeatable prices, but its storage will be full in about another month, leaving Russian crude oil blocked.
With thousands of Soviet-era oil and gas wells in western Siberia, Russia would face the prospect of shutting down and restoring the wells, an expensive proposition and, in the process, could limit permanently the amount of oil recoverable in the future.