Oil Producers in a no-win Scenario with Prices Stalling at $40/b, COVID-19 Risk Remains

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Oil Producers in a no-win Scenario with Prices Stalling at $40/b, COVID-19 Risk Remains
Oil Producers in a no-win Scenario with Prices Stalling at $40/b, COVID-19 Risk Remains

U.S. oil producers continue to fight the fallout from the COVID-19 pandemic as crude oil prices continue to languish near $40 a barrel with little hope for a substantial or sustainable recovery shortly. 

West Texas Intermediate Crude Oil was trading above $70/b in September 2018. If WTI prices were to fall within $10 / b of that number at any point within the next 12 months, independent producers would have good reason to celebrate. 

WTI’s immediate month contract closed on September 23 at $39.93 / b, about 45% lower than the end of September 2018. With demand shaken by the COVID-19 crisis, prices have yet to recover, despite massive production cuts by U.S. companies – and it’s tough to be optimistic that things will improve soon… “$45 is not an easy price to live at; $35 makes it hard.

 It’s going to be an ongoing challenge,” said Duane Dickson, U.S. Oil, Gas & Chemicals sector leader for Deloitte LLP. “In the U.S., we’re probably returning to normal [demand] levels 18 months from now.” However, the WTI forward curve suggests a more pessimistic view. 

Current futures are trading below $45/b through 2023, and are only slightly better in March 2025. In its latest update, released on September 23, the Dallas Fed reported that two-thirds of 154 oil and gas managers surveyed said U.S. oil production had peaked, with just 34% disagreeing. “I’m expecting $45 to $50, and probably closer to $45 seems more realistic,” said Amarillo, Texas-based energy economist Karr Ingham when asked about his projection of WTI prices up in 2021. 

“Here’s hoping we get beyond COVID, and things get closer to normal. But we’re not moving towards that pre-COVID lifestyle very quickly at all right now.”  Judging by the comments on their second-quarter earnings calls, independent producers aren’t optimistic about the coming price hike either. 

Their comments indicated that they believed that the collapse in prices would continue into next year, and their approaches had changed accordingly.

After the producer discussed how they could generate free cash flow at $40/b or below, a clear sign was given that they were preparing for prolonged low prices. “We have a plan for next year to maintain [projected fourth-quarter 2020 production] and generate free cash flow of $ 40 for $ 3.4 billion in CAPEX next year,” EOG Resources Inc. Chairman and CEO William Thomas said. In commenting on second-quarter results, Pioneer Natural Resources Co. President and CEO Scott Sheffield said he expects prices to average around $50 / b for several years, with some years being closer to $40/b and others closer to $60/b. 

Apache Corp. President and CEO John Christmann said his company is looking at $50 / b as a starting point for 2021 but claimed the company would have the flexibility to cut the budget if prices remained below that level.  

Many oil industry veterans repeat the mantra that the only solution to low prices is low prices, or that supply cuts will eventually drive prices up. The supply had already been reduced in the first quarter, and prices hardly moved. With the return to more wells in the second quarter, production is on the rise in areas such as the Permian Basin. “Production in Texas and the U.S. has stopped declining and is increasing,” Ingham said. “All you have to do is restart some wells and complete some [drilled but uncompleted wells], and it goes up.”

In other words, low prices don’t stop low prices, either. This drop in price, observers say, will only be rectified by an increase in demand. Rising gasoline consumption by cars and a return to close to regular air travel will be the engine of a recovery in oil prices, but neither seems imminent.

“Signposts are miles were driven, and traffic patterns from cars and trucks. Also, the aerospace industry and its utilization. If those don’t start to come back, then this is probably where we are for a while,” Dickson said. According to IHS Markit, a resurgence of COVID-19 cases elsewhere in the world has also helped halt the recovery in demand, which had reached almost 90% of pre-COVID levels by the beginning of September. 

“It looks like demand has stalled because of this COVID uncertainty. There’s a lot of concern in Europe now,” Ingham said. In a note to clients on September 23, Goldman Sachs analysts said the market continued to lack confidence in near-term demand and was seeking clarification regarding post-election politics and the growth in demand for oil in the region long term. 

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“Longer-term demand also remains in focus,” the analysts noted, pointing to a recent forecast from B.P. p.l.c. that indicates U.S. oil demand may have peaked in 2019. “We continue to assume demand growth, though at deceleration. However, we believe lower long lead time project spending and slower short-cycle shale growth will offset the slowdown in demand,” the bank analysts wrote. 

If prices do start to come back, they may rise quickly. Morningstar estimated that a relatively small number of shale oil wells would be profitable in its September oil markets even if prices push back over $50/b. “According to conventional wisdom, the efficiency gains that producers have generated since the 2014 downturn has made it possible for shale firms to drill profitable wells, even when crude price Margaery low.

On the contrary, we think only half of the wells drilled since the beginning of 2017 would be profitable today at $55/bbl,” the firm said.  From a somewhat doomed prospect, a large number of executives told the Dallas Fed that they believe U.S. plant counts would increase significantly before prices hit $ 55 / b. Forty-three percent of those surveyed said they expected the rig count would rise substantially if WTI prices were between $ 51 / b and $ 55 / b, while 29% said they thought it would take costs between $ 56 / bbl and $ 60 / bbl. “$60 oil is stimulative,” Ingham said.

 “But I don’t see anything approaching $60. I hope I’m wrong.” While oil companies would like to see $ 60 / billion in oil returns, there is concern that another protracted price drop could be the death knell for a large number of independents. “We looked at negative cash flows and technical insolvency and linked it to oil price and we went with $35,” Dickson said. “At that price, upstream is not making money and it’s not clear what the remedy is.”

Kurt Adam

Kurt is a dedicated businessman and an associate professor at a prestigious university in New York.

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