Oil Market Fallout to Include Consolidation in U.S.; Possible Russia Sanctions From Congress

This article appears as published in Foster Report No. 3290

Shale producers in the U.S. likely will see consolidation as global oil prices continue to reflect the increased supplies and lower demand, analysts said March 11. Bankruptcies resulting in acquisitions could see plenty of assets changing hands, but the price war between Saudi Arabia and Russia may not crater the U.S. shale sector as a whole, officials said during an Atlantic Council session on the recent oil market turmoil.

U.S. natural gas prices already were low before the oil price collapse, and there was not a meaningful difference in U.S. gas prices after oil stayed in the $30-40/barrel range for several days. The U.S. LNG sector has been dealing with limited global demand due to the coronavirus and challenges associated with reaching financial commitments. How the wobbly oil market will affect U.S. LNG project developers is the subject of analysis and will become more clear in the coming weeks.

Russia and Saudi Arabia have engaged in a supply war to see which country can last longest with prices around $30/barrel and several analysts expect the Saudis to gain an upper hand and force Russia back to the negotiating table after failing to reach agreement on production cuts in the face of the demand-dampening effect of the coronavirus. The Russians clearly do not understand how weak their economy is if they think they can outlast Saudi Arabia with oil prices below $40/barrel, said Anders Aslund, senior fellow at the Atlantic Council’s Eurasia Center.

Leaders in Russia and Saudi Arabia miscalculated the effect in the U.S. if they believe their actions will break the shale production sector, said David Goldwyn, chairman of the Atlantic Council Energy Advisory Group. U.S. producers were already cutting costs and struggling with highly leveraged debt positions toward the end of 2019, and the price war will increase the speed of mergers or restructuring of assets, Goldwyn said. He views the effect in the U.S. creating a stronger shale sector, similar to the price drop in 2016 that weeded out weaker players.

Another effect could be Congress imposing sanctions against Russia as lawmakers have freedom to act without fear of an oil price decline, Goldwyn continued. Congressional support for sanctions was rising before the latest developments and if a groundswell of Republicans views sanction legislation as protection for the U.S. producing sector, such a bill could pass with veto-proof majorities, he said.

President Donald Trump has hinted at economic support for different sectors of the U.S. economy affected by the coronavirus and low oil prices, but there has been no details coming from the White House at this point. A purchase of oil to increase supplies in the Strategic Petroleum Reserve (SPR) could help relieve an oversupplied global market and would be more politically tolerable than direct support for the production sector, analysts have said. A planned sale of oil from the SPR by the Department of Energy was postponed March 10, once prices made it unwise to be selling oil in the current price environment.

How long the low prices will last is an unknown tied to both the demand effect of the coronavirus and the political will of Saudi Arabia and Russia, speakers during the Atlantic Council session agreed. “I’m not optimistic we can get a quick off-ramp” before the next OPEC meeting scheduled for June, said Helima Croft, managing director and global head of commodity strategy at RBC Capital Markets.

To have a better sense of how long the price effect will last, more certainty around the coronavirus impact on demand is needed, Croft said. There is a lot of uncertainty at the moment, and the demand picture is among the bigger questions yet to have any clarity, she said.

Russia’s Rosneft Oil Co. is the second-largest oil company in the world, behind Saudi Aramco, and its CEO is close to Russian President Vladimir Putin, neither of which are expected to change the company’s position on supplies anytime soon, said Aslund.

Trump has spent three years telling Saudi Arabia and the OPEC+ alliance to increase production and his first tweet when prices tanked was how the development is good for U.S. consumers, Croft said. Saudi Arabia is not in a position to alienate Trump, but for Trump and those opposed to OPEC+ to advocate more active management of supplies could seem disingenuous, she said.

The speakers debated whether the price decline will result in reduced emissions globally and a faster transition away from fossil fuels. Goldwyn recounted that some analysts believe it might help renewable energy resources by showing that a volatile oil market is less desirable, but he discounted that theory. Cheaper fossil fuels make it harder to sell electric vehicles and for renewable resources to compete on price. The market development is unlikely to result in increased emissions due to climate commitments of many nations, he said.

Jean-Francois Seznec disputed that notion because meeting environmental commitments will take capital, and in the current price environment that money will not be there. Saudi Arabia made a well-publicized commitment on carbon reduction, as did several major oil companies like BP and Chevron, said Sezne, senior fellow at the Atlantic Council’s Global Energy Center. If the low prices extend past June, they could slow down the transition to cleaner fuels, he said.

The latest developments include Saudi Arabia on March 11 announcing a planned increase in production capacity for the first time in 10 years. The country had previously said it would ramp up production to 12.3 million barrels/day in April, which would be 25% higher than February levels. The nation’s energy minister directed Saudi Aramco to invest in additional production capacity to be able to reach a production capacity of 13 million b/d.

The United Arab Emirates (UAE), a major OPEC member, also announced March 11 that it would increase production in April. It set an April production target of 4 million b/d, which observers deemed jaw-dropping because UAE’s current capacity is estimated at 3.5 million b/d.

While some analysts were speculating where all this production would go given the drop in demand, Saudi Arabia announced intentions for loading more supertankers that can carry about 2 million b/d on the seas.

One of the biggest beneficiaries of a price war is China, which should be pleased with a low-price environment and the U.S. shale sector in a weaker position, speakers noted during the Atlantic Council discussion.

In the U.S., oilfield service companies could be the first to feel the impact of deep cost cuts among producers, which has been announced by companies such as Occidental Petroleum, Marathon Oil, and Ovintiv (formerly EnCana). Producers that hedged their output at certain price levels will be better able to withstand a period of low prices, but if global prices stay in the range of $30/b to $40/b, the service companies and producers will see a big market shakeout, according to a report from consultant Rystad Energy.

Exploration and production companies globally are likely to slash capital spending and activities to make up for significantly lower cash flows that are expected to last through 2020 and into 2021. Total expenditures in the sector could be cut by $100 billion in 2020 and another $150 billion in 2021, Rystad said.

The U.S. shale sector will carry the biggest burden, taking as much as a $65 billion reduction in spending if the low-price environment continues, Rystad said. The firm said as much as 5,800 horizontal wells could be trimmed in 2020 from previous expectations, which were almost 11,000 wells. Companies will cancel projects that do not produce revenue, and there are not many that can generate revenue when prices are below $40/b, Rystad said.

The service sector will feel the pain the most in 2020, with the well stimulation market estimated to see a reduction of $25 billion, Rystad said. Fracking and proppant companies will have a hard time securing work amid the cutbacks by producers, besides already contracted deals and jobs associated with drilled but uncompleted wells.

The second-most affected businesses will be those focusing on drilling tools, oil tubular goods, rig equipment and intervention work, Rystad added.

“Unfortunately, this volume war, if it continues throughout 2020 and 2021, will lead to a massive wave of bankruptcies and consolidation in the service market, whose debt obligations are set to grow 27% into 2021,” said Audun Martinsen, head of oilfield research at Rystad. “Companies with low leverage and with healthy order books from past wins in 2018 and 2019 will be able to steer through the storm,” he said.

The cost-cutting among upstream companies had already started late in 2019 and into the first quarter of 2020, but the price collapse created a rush to slash expenditures, with some companies also reducing dividends. Besides Oxy, Marathon and Ovintiv, significant 2020 capital budget cuts were made by Apache Corp., Devon Energy, Husky Energy, ONEOK Inc. and Murphy Oil. Companies are reducing their rig count and well completions planned for the year as they navigate difficult market conditions. Husky, based in Calgary, cut 2020 spending by $1 billion and said it would reduce or halt production where wells are not making money in the current price environment.

ONEOK on March 11 announced a capital spending program reduction of $500 million for 2020. ONEOK President and CEO Terry Spencer said the company expects 2020 financial results to be within previously announced guidance ranges, thanks to activities in the Williston Basin and Permian Basin, even with current commodity prices factored in. Break-even prices for ONEOK’s producer customers have improved over the last several years and provide confidence that the Williston Basin area will remain competitive due to the need for midstream infrastructure to reduce flaring and ethane recovery.

Amid the reduced spending, ONEOK cut back on expansion projects that include a 100,000 barrel/day addition of the West Texas LPG pipeline in the Permian, a 200,000 Mcf/d expansion of its Demicks Lake natural gas processing facility, the Demicks Lake III project and related infrastructure in the Williston Basin. The scope of the liquids Elk Creek Pipeline will be reduced as well, ONEOK said.

“Despite the volatile commodity price environment in recent days, ONEOK’s financial flexibility, significant dividend coverage and investment-grade balance sheet position ONEOK well to weather these challenging market conditions,” said Spencer.

By Tom Tiernan ttiernan@fosterreport.com

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