The United States has been on the opposite side of the OPEC oil cartel for decades in a great battle between the free market and supervised production levels. All that may be about to change, with the free market in the United States giving way to unprecedented action that could direct production levels of its private oil companies, playing OPEC’s game to survive the current crisis.
The U.S. oil industry is very sick and getting sicker by the day.
The negative prices we saw last week, finite oil storage space and the decimation of demand caused by the coronavirus have signaled a radical change in the American shale patch.
The change has been quick and brutal. Just last year, buoyed by sharp increases in natural gas and crude oil output, the United States actually produced more energy than it consumed for the first time since the late 1950s, according to new data from the Energy Information Administration (EIA).
Fast forward four months from December 2019, and we have shale drillers shutting in wells, suspending deliveries to clients, and filing for bankruptcy. Demand for oil has fallen by close to 30% globally and is unlikely to recover anytime soon. Production is also falling—but not fast enough: The OPEC+ cuts won’t take effect until May, and it takes a while to shut-in a well, so the first effects of the cuts are still months away.
Meanwhile, storage is filling up with unsellable oil, both onshore and offshore. Around the world, at least one in every 10 very large crude carriers (VLCCs)—each capable of holding 2 million barrels of oil—is currently acting as floating storage, according to Saudi energy officials. Demand for VLCCs is rising, according to data from Signal Group, but the bookings are not for crude oil deliveries, just for storage.
The United States federal government has leased 23 million barrels of storage space in the Strategic Petroleum Reserve to struggling oil companies.
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A pipeline operator, Enterprise Products Partner, has offered companies to open up the unused capacity of its Seaway pipeline to send oil to the Cushing hub.
Energy Transfer has gone a step further and has asked the Texas Railroad Commission to allow the use of pipelines as storage space.
All these things paint the picture of an industry in a state of panic, and with good reason: It’s running out of options.
In addition to the voluntary shut-ins of wells, the only meaningful move that U.S. oil has is to cut production. Since most U.S. oil companies do not want to cut production except as a drastic last resort, regulators need to step in.
The idea of mandatory oil production cuts like the ones affected by OPEC+ but also by Canada’s Alberta was first floated by Texas Railroad Commissioner Ryan Sitton as a way to mitigate the effect of the Saudi-Russia price war and the looming coronavirus crisis on oil prices. Now, with the war over but the subsequent crisis still in full swing, the idea probably sounds, if not more appealing, then at least more probable.
The Texas Railroad Commission was scheduled to vote on mandatory production cuts this month. Instead, it delayed the vote until May 5, likely in hopes that the situation would somehow resolve itself.
Although some companies such as Pioneer and Parsley Energy are vocal supporters of mandatory cuts, most are against it, notably the supermajors, who are also the most resilient to the crisis.
Of course, there is also negative sentiment to government-instituted production limits. It’s just not the American way to dictate to companies how much oil they should pump—the United States likes to leave that to the oil cartels. But when push comes to shove, some have realized that these glaringly un-American measures might be the industry’s only hope.
And despite the blowback on legal grounds, there is no legal obstacle, either, according to a Reuters round-up of lawyer opinion. It is illegal for companies to agree on production limits amongst themselves, as this would constitute a cartel under U.S. antitrust law. It does not, however, prohibit state or federal regulators from imposing a production limit.
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“Trump himself, other federal officials, and Congress cannot violate antitrust (law) by any official actions they take. It doesn’t apply to them,” one antitrust law professor said.
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One may ask why the industry would need mandatory cuts if it’s already cutting by default due to market pressure? After all, President Trump himself said U.S. oil production would decline organically, thanks to low oil prices. However, prices have fallen way too low and too fast, and an organic decline will not be fast enough to respond to the situation, which would justify mandatory cuts.
And while Texas and its oddly named Railroad Commission have stolen the limelight in this respect, it is not the only state considering mandatory cuts. In a recent notice, the North Dakota Department of Mineral Resources is also set to discuss whether producing low at current prices is not a waste of resources, suggesting that they may be preparing for mandatory cuts, too.
So, the chances of state regulators imposing production limits on oil companies are growing increasingly more likely. The question of whether they would work fast enough to revive the U.S. oil industry, however, remains. Some, such as the government in Washington, are optimistic. Others, such as Art Berman, not so much.
One thing is for sure, though. The effect of this crisis on the U.S. oil will be even more transformative than the shale revolution.
By Irina Slav for Oilprice.com
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Let me hasten to add that OPEC isn’t a cartel and has never been one since its foundation in Baghdad 60 years ago. In fact it was founded to confront the true cartel of the Seven Sisters (the world’s largest seven oil majors) which controlled global oil production, marketing, refining, exploration, supplies and prices.
Far from abiding by the dictates of a truly free market, the US shale industry did exactly the opposite. Since its inception in 2008 the US shale oil industry has never been a profitable industry. If it was judged by the strict commercial criteria by which other successful companies are judged, it would have been declared bankrupt years ago.
US shale drillers have been encouraged by easy liquidity provided by Wall Street and other investors to continue production even at a loss to pay some of their debts. In so doing, their outstanding debts have mushroomed to almost $1 trillion leading to large number of bankruptcies among them.
Where were the rules of the free markets when US shale oil producers have for years been taking advantage of OPEC+’s production cuts to enhance their market share at the expense of OPEC+ members by producing excessively even at a loss and undermining OPEC+ efforts to support oil prices by trying to cap them. Shale oil producers didn’t even spare a thought for other oil-producing nations of the world whose livelihood they have trampled on for years with the full knowledge that US tax payers will bail them out even when their outstanding debts are heading towards $1 trillion. They had a chance recently to redeem themselves by cutting their production and joining OPEC+’s efforts to stabilize prices but they adamantly refused.They paid for their greed and obstinacy by the recent collapse of the WTI crude oil price to less than $1 a barrel.
How could they be abiding with the dictates of the free markets when they expect American tax payers to rescue them from bankruptcy. Mandatory cuts are the only way to save US oil.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London