Oil markets are looking particularly bearish this week, with WTI once again below $50, the OPEC cuts in jeopardy over Iran and Iraq ramping up production, the second U.S. shale revolution underway, and an overwhelming U.S. supply glut which shows no signs of easing. In this environment, signs that President Donald Trump’s energy policies could further disrupt markets are worrying for the industry.
With his pro-drilling nominations for the Departments of State, Energy, Interior, and EPA, the American renaissance of oil and natural gas production is set to skyrocket, which will cause prices of WTI and Brent to move lower in the foreseeable future. Some of the geopolitical conflicts that could offset this downward pressure are: 1) Rising tensions in East Asia involving the U.S., China, South Korea, and Japan, 2) Iran’s aggressive stances towards the west, 3) Russia’s movements against NATO in Ukraine, and 4) the possible collapse of Venezuela.
But for now prices seem to be stuck on a downward trajectory because there is still too much supply on the market and record amounts of storage according to the EIA. While hedge funds have made historic long investments that prices will move upwards, they don’t seem to have factored President Trump’s policies into their positions. Nor has anyone else, and that’s where the danger for investors and prices lie. If those positions continue being held and expanded, those funds, and their investors, are opening themselves up to the possibility of a sharp fall. The same way so many were caught off guard during the last severe downturn in prices.
To add to this, the U.S. shale boom appears to have returned in full force. The number of oil and gas rigs in the U.S. has doubled from its lowest level in seventy-five years. And while OPEC continues to record high production cut compliance rates, larger than normal global supplies are keeping oil prices depressed. Since late 2016, U.S. output has increased by half a million barrels a day. If this rate endures, the new shale boom will break all-time high production levels by this summer. Related: Rise Of U.S. Shale Could Jeopardize OPEC Deal Extension
This shale boom is different however, with the industry having been transformed by the oil price crash. After 2014, drilling operators shut down rigs at an unprecedented rate, but what rose from the ashes was an industry that employs fewer workers, has less rigs producing more oil through automation while employing nearly 90 percent of all new rigs on shale formations. The U.S. is now producing over 9 million bpd, and it took twice as many rigs in 2014 to yield that amount. What shale drillers are doing is unprecedented, and they will continue to become more efficient while attracting some of the best-capitalized oil and gas companies in the world to further their gains.
That is why Harold Hamm, the billionaire shale oilman said this at the CERA Week by HIS Markit conference in early March: “The U.S. shale industry could ‘kill’ the oil market if it embarks on another spending binge. It has to be done in a measured way.” The U.S. government has also announced that by next year domestic oil output will surpass the record high set in 1970.
What formerly held shale back was high break-even costs, but now break-evens occur in the sub-$30 prices throughout the Ford and Permian basins. A staggering drop considering the obstacles they have overcome in the last 2-4 years. This means shale players can spend more to ramp up further production while remaining profitable. Moreover, President Trump will encourage this policy, and the success is being seen with his recent strong jobs report numbers. All signs point to further exploration (even in places like Alaska) with a compliant administration that wants the high-paying jobs from the fossil fuel industry.
The one issue that could somewhat stall production and raise break-even costs for shale drillers is the rising cost of frac-sand. Still if shale drillers overcame the 2014 crash, it seems they can overcome higher frac-sand costs. It’s also not out of the realm of possibility that President Trump and his Cabinet wouldn’t ask Congress to tweak the tax code to allow tax breaks for shale drillers if costs for frac-sand, water, or chemicals rise above acceptable rates.
Though all of the above issues and concerns can either depress prices or raise them, what isn’t being discussed is how President Donald Trump’s energy policies could make oil and gas stagnate or dip into the $30 or lower range. He has come into office promising to be the biggest defender of fossil fuels in a generation. He has already used his executive powers to authorize the construction of the Dakota Access and Keystone XL pipelines. By this action President Trump has brought back a possible 1,280,000 bpd (450,000 from Dakota Access and 830,000 Keystone XL) that wasn’t factored into the OPEC compliance cuts.
As an example of what can be done for E&P in America under Trump, we’ve already seen resurgence in the coal industry under his administration. Coal production, and areas of the U.S. heavily dependent upon those jobs that coal provided, was dying off under the former U.S. administration’s tough anti-coal regulations. Yet now they have rebounded after Trump rescinded the stream protection rule. West Virginia and Pennsylvania have credited the rebound in the region’s coal mining areas with President Trump’s “aggressive, pro-energy agenda.” Prices for metallurgical or “met coal” – the type of coal used to make steel – has doubled in price from a year ago.
Imagine what will happen for U.S. shale drillers and the fossil fuel industry in general if this pro-energy President and his Cabinet departments that control oil production does for the drilling business what he has already accomplished for coal prices. The U.S. could overtake the Saudi’s, Russians and other high producers before his first term ends under current pro-drilling conditions. Related: Why Is Big Oil Backing The Paris Climate Agreement?
No longer will fossil fuels be as harshly regulated as they were by the former administration that wouldn’t allow drilling on federal lands, enforced penalties on coal-fired power plants, mandated strict regulations on methane emissions and strongly emphasized renewable energy and electric vehicles over growing fossil fuels. Instead, after years of having to overcome these regulations, the oil and gas industry in theory can bring as much product to the market for domestic use and export as the market can handle.
Cautious optimism should inform energy investment decisions, and while OPEC compliance cuts are important, you should factor the pro-drilling Trump Presidency on oil prices. Otherwise, it will be difficult to understand why WTI and Brent are stuck in the 50s or lower. In addition, if hedge funds haven’t understood this phenomenon, then governments taking their advice and the investment vehicles they manage that are dependent on higher oil prices could see huge losses in upcoming financial reports.
President Trump like President Obama is a transformative presence. To not account for how he and his Cabinet will directly create millions of bpd of new oil for the market is to not understand how his energy policies will affect prices. Hopefully, investors, companies, and governments have considered President Trump into their investment risk premium.
By Todd Royal for Oilprice.com
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The OPEC production cut shifted sentiment for a while, but really didn't alter the supply demand balance. I find it highly unlikely that SA will choose to cede more market share to shale after the current agreement expires.