An Oil Production Fall for the Record Books
From March to July 2020, United States crude oil production fell from 13 million barrels per day to 10.5 million. This decrease in production helped oil prices recover from below $0 in late April to around $40 in July as some semblance of supply-demand balance returned. The reduction in output was achieved through a combination of shutting-in existing wells, and a cessation of new drilling. Percentage wise, this approximately 20% drop is the largest since the financial crisis in 2008.
The United States was not alone in its efforts to curtail production in order to support crude oil prices. OPEC+, led by Saudi Arabia, agreed to cuts of nearly 10 million barrels per day. This came after Russia and Saudi Arabia initiated a price-war in an attempt to capture market share previously lost to the United States during its rise to the top oil producer in the world. The price-war and COVID-19 were the primary drivers of the oil price collapse. By some estimates, COVID-19 lockdowns removed nearly 30 million barrels of crude oil demand from the market.
Deck Stacked Against Operators
Despite the rebound of WTI to $40 per barrel, oil prices are still ~35% below where they were at the start of 2020. Several U.S. shale producers were already on the brink of bankruptcy before the crash. $40 oil tipped several notable ones over the edge, including shale pioneer Chesapeake Energy and Bakken behemoth Whiting Petroleum. Many more bankruptcies are expected unless there is a meaningful uptick in crude oil prices in the near-term. Most U.S. operators need oil prices north of $40 per barrel simply to breakeven, let alone turn a profit. Further compounding the problems for operators is that natural gas prices have fallen to multiple-decade lows in recent weeks. Natural gas demand, like crude oil, has fallen precipitously due to COVID-19.
A tension now exists for operators between restarting activity and supporting oil prices. If they are too quick to start pumping at record-levels again, they may flood the market, sparking another price drop. With a potential second wave of COVID-19 looming, demand could see another sharp fall, further putting downward pressure on pricing. It is somewhat of a vicious cycle at the moment. Operators need the cashflow that pumping oil and gas generates, but run the risk of driving prices so far down that they end up selling at a loss, expediting their own demise.
What is to be Done?
In order to survive, operators will likely need to leverage technology to significantly reduce operating costs in order to make $40 oil profitable. For some, it is probably too late and it is simply a slow march towards their death.
The drilling frenzy that the shale revolution ignited, and which Wall Street investment fueled, is likely a thing of the past. Wall Street insisted companies grow, which due to the rapid decline in output shale oil wells experience, could only be driven by ever-more drilling. Operators kept pushing the issue of a lack cashflow into the future. There was too much reaping and not enough sowing. Hopefully everyone in the industry and Wall Street have learned this lesson and will employ a more measured approach as we emerge from this epic bust.
