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Robert Rapier

Robert Rapier

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The U.S. Can’t Afford To Let Shale Fail

It’s no secret that the growth of U.S. shale oil has been a thorn in the sides of both Saudi Arabia and Russia. They have seen their market shares erode as the shale boom made the U.S. the world’s largest producer of crude oil. But Saudi Arabia’s national oil company, Saudi Aramco, is a single entity that produces 13 percent of the world’s oil and controls 17 percent of the world’s proved reserves. That puts them in a very powerful position. They can withhold a lot of oil from the market, or they can flood the market with oil and crash the price.

I have warned many times that Saudi Aramco’s power shouldn’t be underestimated, even as some were suggesting the shale oil had rendered OPEC (which they control) toothless. In an article I wrote in 2016, I observed:

“OPEC is a big reason oil prices fell into $20s earlier this year, and they were a big reason oil prices were at $100 a few years ago. What other organization has the power to move the price of oil so dramatically — both up and down? That is real market power. So they may sometimes behave like a paper tiger. But they are capable of rapidly moving the global oil markets.”

Saudi Arabia should not be underestimated. They started a price war in 2014 that drove oil prices into the $20s. No other single entity could have done that. The strategy temporarily stalled U.S. oil production, and although they did bankrupt a few shale oil producers, the industry proved resilient. So Saudi Arabia switched back to cutting production to prop up prices in 2016, and until recently they had maintained that strategy.

Related: Oil Hits $20 For The First Time In 18 Years
But this year’s coronavirus (COVID-19) outbreak has caused an enormous decline in oil demand, putting oil under tremendous price pressure. Saudi Arabia wanted more emergency production cuts in response. They had been working with Russia to enact this strategy.

This time, Russia said “Enough is enough. No more cuts.” So, Saudi Arabia responded by ramping up production. When they did so, we saw a mind-boggling 30 percent drop in the price of oil overnight.

However, this time Saudi Arabia may succeed where they failed in 2014. They struck at a very vulnerable time. U.S. producers were already reeling from the decline in production, and this now places them under tremendous pressure.

The energy sector is suffering from a triple whammy. The collapse of oil demand, the overall decline in the stock market, and finally – and most importantly – the price war that Russia and Saudi Arabia have started have crushed the U.S. energy sector.

Now I am seeing some sentiment from people that we should just let the industry go bankrupt. I have seen people cite the oil industry’s subsidies, or the fact that too many producers took on too much debt, and that it should therefore be allowed to fail.

Let me make a brief point about subsidies. Recently, President Trump suggested using funds from a program that helps low-income Americans afford heating oil to combat coronavirus. Some Democrats howled at the potential cut in this program.

Well, guess what? As I have pointed out in the past, that’s an oil subsidy. The reality is that the vast majority of oil subsidies in the world are consumer subsidies like this. The people who get angry about oil subsidies are sometimes the same people that complain about cutting these kinds of subsidies — because they don’t recognize them as oil subsidies.

Subsidies aren’t direct payments to oil companies, even though that’s what most people envision. So, they get angry about something they misunderstand.

That’s the first point. But a more important question to ponder is “What are the consequences of letting the U.S. shale oil industry go bankrupt?”

Related: Oil Prices Slide As Saudi Arabia Confirms Another Export Boost

Look, you may think the U.S. oil industry deserves to go bankrupt. You may believe we should all be driving around in wind-powered electric vehicles or riding bicycles. But that’s not the world we live in today.

Should we use less oil? Yes. And we will over time. But right now the U.S. still uses a lot of oil, and we will continue to do so for several years, even as we transition to electric vehicles.

The real consequences of letting the U.S. shale industry fail is to hand global control of oil production back to Saudi Arabia. Millions of Americans will lose jobs, domestic oil production will fall, and our oil imports will soar. Saudi Arabia will then be free to once again withhold production to drive up the price.

Some producers will go bankrupt as a result of the current crash. And those that made really poor decisions should go bankrupt. But letting too much of the industry fail will begin toppling dominoes that will have enormous ramifications on the U.S. economy and on our national security.

Russia is going to make decisions about the interest of its domestic oil industry. Saudi Arabia is going to do the same, and it has a powerful instrument with which to do so through Saudi Aramco.

The U.S. must do the same, but there are those in government that seem like they would be glad to see the oil industry go out of business. Unlike Russia and Saudi Arabia, our oil industry has decidedly mixed support from the federal government.

The American economy runs on energy. The energy industry is a matter of national security. We can’t give up control of our energy security to Saudi Arabia. That is the consequence of letting this price war destroy the U.S. oil industry.

By Robert Rapier 

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  • peter mueller on March 31 2020 said:
    Mr. Rapier made his point. Even Europeans nor Russian would argue totally against. The Main Problem with Shale Oil is very capital intense and many very small players. Interest Rates above 6% for over a decade. A large company "like Lukoil" has only about 5 Bio. USD outstanding in Bonds (Interest average about 5.25%) that's far below th Shale Oil Companies. Those companies are highly inefficent use mostly Spot Market Contracts which is not helpful.
    Oil Quality is low compared to Top Class Iranian Oil. It's about from 1 to 5 best to worst Level 3-4 Oil, Level 5 would be Canadian Sand Oil quality which is far below 10 USD in price. Top Iranian Oil is still around 30 USD. Mr. Trump and Pompeo hat started this Crash with useless boycotts and overplayed the US hand. Haynes and Boone published the Oil Patch bankrupty Monitor 2015 -2019. There was and is a steady decline of the Shale Oil Companies.
  • Mamdouh Salameh on March 31 2020 said:
    The author seems to be hoodwinked like the rest of the world by the Saudis over the size of their proven oil reserves and their production capacity and also by their claim that they plan to flood the market with more oil by raising their oil exports from the current 7 million barrels a day (mbd) to 10.6 mbd in early May. Except all is not true.

    Since the early 1980s Saudi Arabia has flooded or claimed to have flooded the global oil market three times with oil very unsuccessfully. The first time was in the early 1980s in collusion with the United States to undermine the former Soviet Union. It ended bankrupting itself in the service of the United States.

    The second time in the aftermath of the 2014 oil price crash which had its seed in the 2008/9 financial crisis and not caused by Saudi Arabia flooding the market as the author mistakenly assumed. Again it ended losing $116 bn and sustaining huge budget deficits of $140 bn in 2015 and $134 in 2016.

    Now Saudi Arabia is threatening again to flood the market with oil by early May by claiming that it will raise its oil exports from the current 7 mbd to 10.6 mbd. However, to raise its oil exports to 10.6 mbd, Saudi Arabia must also raise its current production to almost 13.00 mbd including 3.7 mbd for domestic consumption.

    But Saudi Arabia has never ever had such a production capacity and will never ever achieve one. So the talk about raising its exports to 10.6 mbd is a farce. Its production peaked at 9.65 mbd in 2005 and has been in decline since. Saudi Arabia can at best produce some 8.0-9.0 mbd with another 700,000 b/d to 1.0 mbd coming from storage. This is so because its current production comes from five giant but aging and fast-depleting oilfields discovered more than 70 years ago.

    A continued price war could cost Saudi Arabia a budget deficit estimated at $116 bn in 2020. To this could be added another loss of $200 bn being a 10% devaluation of Saudi Aramco’s shares raising the total to $316 bn.

    As for the US shale oil industry, it was on the verge of bankruptcy long before the onset of the coronavirus outbreak. The outbreak and its atrocious impact on the global economy, the global demand and oil prices has made life unbearable for every one particularly the shale industry.

    The shale industry could emerge from this ordeal leaner with very few drillers who may stay alive slightly longer on a life support machine provided by the Trump administration and bailed out for the time being until its outstanding debts start to mount again.

    Since its inception in 2008 the shale industry has been producing oil even at a loss with easy money provided by Wall Street and other investors just to enable the United States to have a say in the global oil market along Russia and Saudi Arabia. In so doing, it has not only been depriving the majority of the world’s oil producers of their livelihood but also preventing oil prices reaching a fair level for both consumers and producers and also showing the ugly face of capitalism.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London
  • Bradley Steeg on March 31 2020 said:
    RUS and KSA understand production cut price supports only serve to subsidize US shale. They aren't attacking US shale right now they're panicking from a severe demand shock.

    US shale is also panicking and begging for government intervention to save their investments because RUS and KSA ain't gonna do it.

    However, if the government saves existing shale companies it will only help current shale investors. It won't help our advanced diversified economy. The simple fact that shale is a proven technology is all the US energy security we need. In fact, it's much better to keep US shale safely stored in the ground and buy inexpensive RUS and KSA oil.

    The one exception would be if US shale innovated to produce net-zero carbon oil. In that case, we'd want to mandate emission reductions in the airline and cargo industries.

    So, what should the US govt subsidize right now? Capital intensive energy that benefits from low interest rates. Yep, solar and wind. Not nuclear because it's too expensive. How could that help US shale? Solar panels in the Permian could help power carbon air capture.

    In addition, we should try to get as many PHEVs on the road as possible. Reducing demand for oil improves US energy security. Therefore, give PHEVs larger subsidies than EVs.
  • Lee James on March 31 2020 said:
    Mr. Rapier, I'm trying to understand your position on propping up the U.S. shale industry. As I understand it, investors gambled that technology would develop to the point of making the industry profitable. It was already a failing industry as the virus hit.

    I think perhaps investors were overly speculative. Think what they did: investors took short-term advantage of very low borrowing rates to go after the toughest oil to extract -- around 10,000 feet underground (often with almost as long laterals) where it is dispersed over wide areas in low oil-to-shale concentrations. We pump millions of gallons of high-pressure water to force oil out of source-rock shale formations.

    Unfortunately, the price tag for such expensive extraction is coming due. Time was already up, even before the virus. Am I to understand that American taxpayers are to come to the rescue of investors who placed a very questionable bet?

    It's not like oil is unavailable in the world. Maybe Americans should entertain a completely different energy future -- with less dependency on oil? Presently, we have no national energy plan, other than saying burning fossil fuel is beautiful.
  • John Galt on April 02 2020 said:
    Putting things into perspective, we have about 30 years left before we are pretty much done with fossil fuels. Paradigm shifts like this create market instabilities, and as a country we need to insure a steady supply of energy at reasonable prices both to protect our consumers and even more importantly as a national security issue.

    I generally hate protectionism of any kind, but in this case I think it would be reasonable to keep our shale producers profitable enough to keep paying their bank notes. The easiest way to do that would be an indexed tariff on imported oil from anywhere except Canada and maybe Mexico such that it produces a "price floor" to keep our shale making a minimum of profit. North America that way nets out of the world market while Russia and the Saudis play price games, and once they finish their fight and prices go up again the indexed tariff automatically becomes zero, making it a global market again.
  • Rudolf Huber on April 02 2020 said:
    COVID-19 shows what happens if one lets other countries run essentials one needs. In Austria, we don't even make those crappy face masks and disinfectant ourselves. We must import most of the stuff we need to function. And when the crap hits the fan, we turn into turds in record time. Energy is absolutely essential and shale gives the US more elbow power than 5 carrier groups: Trump must kick off the rebuilding of US industry and this can't be done by letting shale go to the dogs. The new world will not run on the tools of the old world. Globalism is great when all countries live by the same or similar values. Until then, if you want peace, prepare for was. And war costs money.

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