An Existential Moment for Texas Shale

Predictably, the Saudi-Russian oil war against U.S. shale and the entire rest of the world ended quietly earlier this week.  Neither Saudi Arabia nor Russia had the will (nor, arguably, the level of stupidity) to throw shade at U.S.producers while they unnecessarily threw away tens to hundreds of billions of dollars of surplus currency reserves for no apparent rational purpose.  While hailed within the U.S. media for giving life to the oil and gas industry, this is a mistaken and misleading conclusion to make.

First, oil supply would have been curtailed naturally, without cartel agreements, as there is not enough storage to hold oil being generated due to the collapse in demand following the coronavirus pandemic igniting.  Supply would have shrunk, dramatically, without any cartel intervention, as there is no place to put it and nobody wants it.

Second, the only cure for the oversupply tsunami is a revitalization of global economic activity once the virus has been adequately contained.  Demand has to more closely match supply before there will be any price relief for oil producers.  Until then, producers may have to face an unprecedented level of price destruction – at some point, it may come to producers paying customers to take the oil off of their hands!

Third, a wave of capital destruction is unavoidable.  There will be dozens of bankruptcies, and many of these companies even after emerging from bankruptcy will be a shadow of their former selves.  This is an oil disaster exceeding, at least in the short term, even the dark days of the 1980s.

Fourth, even if prices eventually return to profitable levels for drillers, drilling activity is unlikely to even approach prior highs.  The service companies necessary for well drilling, fracking, and completion, are going bankrupt in droves, or in the best of cases, retrenching to a historical degree.  Even the big two service companies, Halliburton and Schlumberger, are laying off thousands of workers.  Even if oil prices recover, the staffing will not be there to dramatically increase activity in the oil patch.

Ironically, perhaps the largest beneficiary of this oil industry wasteland will turn out to be the natural gas industry.  Ancillary gas produced by Permian field wells is going to plummet over the next year, as will gas from the largest gas basins – Marcellus/Utica, Haynesville, and Eagle Ford.  Until a month ago, natural gas was already in a historically significant bear market, due to years of overproduction and excessive supply, despite robust global need for natural gas and LNG.  Now with the pandemic, oil has surged past natural gas in the race to the bottom.  Strange times, strange markets.

Demand for natural gas diminishes less than that for oil in a pandemic, as natural gas primary uses include electricity generation, heating, and cooking, not automotive or airline fuel.  So with demand declining to a smaller degree, and a large amount of supply coming off the market in the next three to fifteen months, the multi-year glut of natural gas supply may go into deficit vis a vis demand as soon as this coming winter.  Natural gas investors may confront a completely unexpected bull market soon, after years of price and equity weakness in the sector.

A final “law of unexpected consequences” byproduct of the Saudi – Russian war may, ironically, be yet another extreme swing in commodity prices – the pendulum swinging wildly the other direction in two to four years.  The natural rate of depletion in global oil supply is somewhere between five to seven percent a year, which today is five to seven million barrels of oil.  Producers have to find five to seven million new barrels of daily supply just to keep global supply steady, year over year.  With huge cutbacks in shale drilling and outright cancellation of large offshore and conventional projects, even when demand comes back and OPEC++ reverses this artificial reduction in supply, whatever that reduction eventually turns out to be, there may not be enough renewed supply from non-OPEC sources to match demand.  Frankly, it may not even be close.  

If prices on West Texas Intermediate (WTI) crude eventually get back to sixty dollars a barrel, or even progress far beyond that, the capital and personnel necessary to dramatically ramp up shale and large conventional production simply will not be available, even if the desire is there.  The skepticism for the shale industry and the negativity surrounding it are so deep and broad that the money to “drill baby drill” and the people to do the work will not quickly come back.  It will take years of high oil prices until the scars of the oversupply of the shale revolution are a distant memory and new capital and personnel swarm back in to the industry.  It may be hard to imagine today, but you go out several years and oil prices may return to sixty, eighty, or even more than one hundred dollars per barrel.

The only certainty you can point to in oil and gas over the decades is volatility, and the larger the price swings, the larger the counter-swings in price will be in the opposite direction.  If you do not believe me, let us discuss it in four years and see where we are then.

The current reality however, is that the oil and gas industry, as well as oil and gas producing states, are in for one of the worst six to twenty-four month periods ever.  Bankruptcies, job losses, and deep retrenchment in a national security level of importance industry are certainties.  The OPEC++ deal, brokered at least in part by President Trump, will do nothing to change that fact.

Strap on your crash helmet, and get ready to roll on impact.  Some will roll away from the fireball post-crash, some won’t roll in time.

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