At a Glance
- WTI crude oil prices fell more than 40% after the Saudi-Russia price war, then continued falling after the production cut announcement
- Even with a deal to cut oil output, the U.S. shale industry could see more bankruptcies in 2020
A few things will go back to “normal” once the COVID-19 pandemic is under control, but somethings may not. The U.S. shale oil industry is one of them.
The shale oil industry had been on the rise and it appeared there was very little that could derail it. Innovation and technology drove the growth of the industry, but so did debt. The industry has historically produced a product in huge demand globally, and that demand had been growing.
In the span of only seven years, U.S. shale oil production grew to over 4 million barrels per day from around 400,000 barrels per day (bpd), topping out at 12.23 million bpd. The only real hurdle the industry had was a surprise, rapid drop in the price of crude oil. Even a slow drop could potentially be managed and hedged, but an all-out collapse would spell trouble.
When Oil Began Slipping
Starting in October 2018, the price began slipping, well before the spread of the novel coronavirus. Demand destruction began with the U.S.-China trade war and accelerated with the potential U.S.-Europe-Japan trade war. Then the USMCA passed and the Phase 1 deal between the U.S. and China was signed in January 2019, and prices began to recover.
Those early price drops paled in comparison to what happened next, which is clearly visible on the right side of the chart, and continued after the announcement of a 9.7 million bpd OPEC+ production cut.
Trying to manage falling demand exacerbated by the pandemic, OPEC agreed to cut oil production by an additional 1.5 million bpd through Q2 of 2020 (a total production cut of 3.6 million bpd from the original 2016 agreement).
OPEC called on Russia and other non-OPEC members to join in the cuts, but on March 6, Russia rejected the demand marking the end of cooperation, and a 40%+ drop in prices followed.
The conflict was about a strained allegiance between the Saudis and the Russians, but U.S. shale would be hurt badly.
Following the 9.7 million bpd cut announced April 12, crude rallied 8%, then fell, with CME Group’s WTI futures contract breaking below $20 a barrel. Cuts are stabilizing, but they do nothing for the demand destruction that is happening.
So, what’s next for shale? There have already been two bankruptcies, and more could follow.
“There will be a wave of bankruptcy filings this year,” said Spencer Cutter, of Bloomberg Intelligence.
Nearly 100 U.S. oil and gas producers could file for Chapter 11 over the next year, according to Buddy Clark, co-chair of the energy practice at Houston law firm Haynes and Boone as reported by CNN.
That’s close to the same number of bankruptcies in all of 2015 and 2016 combined when oil prices crashed to $26 a barrel. Shale drillers have a pile of debt coming due later in 2020, and they have less of a chance of refinancing than they did six months ago. That could be a trigger for a wave of shale patch bankruptcies.
Reduced U.S. Production
Despite President Trump’s efforts to get prices back up and reduce impact to the oil industry, shale production was set to fall anyway, in the range of 500,000 to 1.2 million bpd. The shale patch has been borrowing, spending and expanding for a decade, and that strategy failed to produce profits.
“The drumbeat has been loud and uniform from investors,” Parsley Energy (NYSE: PE) Chief Executive Officer Matt Gallagher said in January of this year. “The shale producer’s spending next year will drop about 15% and will not rise even if oil prices do, instead using higher returns to pay down debt,” he said.
Those prices didn’t rise, they fell dramatically. That was before the pandemic. The first case of COVID-19 in the U.S. was reported on January 20. WTI crude oil prices had already fallen 7.4% from January 6 through January 15. If we go all the way back to Oct. 3, 2018, WTI had fallen 18.9% through Jan. 15, 2020. The subsequent economic shut down brought more potential demand destruction and lower prices. Then the April 12 production cut did not stop the slide.
Baker Hughes oil rig counts have fallen to their lowest levels since 2017, having lost 179 rigs in four weeks. If these dismal reports continue, we could see the United States fall way down the list of top oil producers in 2020.