Below are the speaker’s notes from an online presentation delivered today to members of the Alaska Support Industry Alliance.  Their thousands of employees of some 400 employers provide the muscle enabling the enormous oil, gas and mining production in America’s largest — and sole — Arctic state.


Alaska Support Industry Alliance Webinar Briefing For Members

By

Dan K. Eberhart, Canary LLC (Photo)

(Twitter account contact: @dankeberhart)

Whatever happened to “In like a lion, out like a lamb?” March has been a month many of us would rather forget. The twin black swans of the response to a global pandemic that delivered a massive negative demand shock and the collapse of the Saudi-Russia alliance have been a body blow to US shale.

  • Oil demand is projected to decrease by 9.4% for 2020, or 9.4 million barrels per day.

Total oil demand in 2019 was approximately 99.9 million bpd, which is now projected to

decline to 90.5 million bpd in 2020. (Rystad)

  • April may take the biggest hit, with demand for oil estimated at 72.6 million bpd, falling

by 27.5 million bpd. Similarly, May’s demand is expected to fall by 19%, or 19.1 million

bpd to 79.9 million bpd. (Rystad)

  • The response to the pandemic — travel restrictions, quarantines — is exacerbating the

demand-side challenges, so in the short-term supply is the one side of the leger we can

move. But supply takes time to throttle back — and it is brutal on those of us who do the

drilling and provide other field services — so it will take time for the market to find

balance again.

  • ConocoPhillips shutdown of all drilling activity on the North Slope for 2020 is devastating – made all the worse by the fact that it was supposed to be a big year for exploration and construction — our bread and butter.
  • The most important thing right now is to protect our employees – their health and their economic security. It’s the right thing to do and we will need our workforce intact when the economy starts back up.
  • OPEC and Russia meet today. Russia says it is willing to reduce production by 1.6 million barrels per day, which made oil futures jump 6.2 percent – the market is anxious but there’s optimism. Oil prices were up over a dollar on the open today.

International Cooperation

  • Saudi Arabia is looking toward oil producers among the G20 nations to bolster any

OPEC-plus actions. Of the list of G20 countries, only a handful have any significant oil

production, and even fewer have any sort of export capabilities. Chief among these is the

United States, but other major producers include Brazil, Canada, and Mexico. Norway

has said they would join, too.

  • As of this morning, there is still disagreement between Saudi and Russia about how much

total needs to be cut: 10 million barrels a day in global cuts may not be enough.

○ Saudi needs to ratchet back to 9 million barrels a day, which means cutting 3

million bd.

  • The other sticking point is that Russia needs to move off its position that the U.S.

formalize production cuts. The U.S. is already cutting in response to the market and it has

few options for mandating lower production.

○ Russia is fed up with yielding market share to shale and is insisting we share the

pain. Russia has taken advantage of this downturn to hit the U.S. But the

downturn has been so severe that even Russia needs a return to normal. Putin

cannot address domestic priorities at current price levels. The Urals oil price was

down to $12 a barrel. Once the Urals oil price gets close to $10/bbl, Russia starts

to suffer. Closer to $20 is fine with Russia (but still not particularly great).

○ Russia can get what it wants at a slightly higher price, say between $30-$40 a

barrel, that a global deal could create.

OPEC+ Russia Meeting on Thursday

  • The Saudis and Russia made an opening bid. They want to see what the G20 response is;

hoping to convince those with oil production to share more of the pain by making higher

cuts. Tomorrow’s G20 meeting will show whether we have a deal or no deal.

  • US is not mandating cuts.

Where the U.S. industry is on cuts

  • There is not universal agreement that we should be trying to limit production. API and

the majors have resisted calls for the U.S. to impose limits on production. The big

integrated companies can sell to their own refineries and invest in storage; smaller

companies don’t have the same flexibility.

  • Pioneer’s Scott Sheffield and Jeff Hildebrand of Hilcorp Energy have been outspoken of

the independents for the need for the US to cut production to get a deal with OPEC+.

They have accused the majors of trying to drive small players out of the industry.

○ It’s never good when there’s division within our own industry – not speaking with

one voice. But everything points to the U.S. arguing that market-driven cuts will

be long term and that more formal cuts aren’t needed from U.S. companies. The

majors have President Trump’s ear and that’s why you’re hearing him talking

about the free market.

○ First, federal antitrust laws prohibit companies from setting prices for a

commodity. Second, while states can impose restrictions on production within

their borders, they can’t do much about a company one state over who decides to

take advantage of a unilateral agreement to grab market share. Two dozen oil-

producing countries are easier to corral than a hundred wildcats.

  • The Texas Railroad Commission has the power to allocate production volumes and has

exercised it extensively in the past, but not since the 1970s.

○ RRC Commissioner Ryan Sitton has pitched just such a plan and pushed it to

officials from Russia, Saudi Arabia and Canada, among others. But Sitton only

holds his office until November after losing a primary election.

○ Sitton says Texas could cut “as much as needed” and that he was reaching out to

other state regulators to prod them to join. The Permian Basin alone produces

about 5 million barrels a day, or 40 percent of total U.S. output.

○ Fellow commissioners have also been reticent to endorse Sitton’s overtures, but

Chairman Wayne Christian has come out in support of the president’s

negotiations with Saudi and Russia.

○ By law, U.S. producers are prohibited from coordinating among themselves in

any way that could impact prices. Voluntary cuts are already under way and more

seem inevitable given prevailing oil prices and physical market constraints.

○ Pioneer Natural Resources and Parsley Energy have formally requested that the

RRC return to market management. So, while a coordinated cut might be

impossible, material production cuts in the United States would appear likely,

whether or not there is an official deal to do so.

  • The EIA short-term forecast is interesting. They are predicting US production next time

this year will be nearly 2 million barrels a day lower. 11 million b/d. We had been

peaking at 13 million bd. Are they signaling to OPEC and Russia that U.S. production

cuts from market forces alone are real? (EIA is an independent agency, but….)

○ API’s Mike Summers said 25 percent to 35 percent of U.S. output could be shut-

in due to market forces already.

○ Railroad commission says there will be a 20 percent reduction of oil coming out

of Texas because of market forces already.

  • A reduction in output alone is also not going to correct the fundamentals of the market.

Demand has to return and we have to start to draw down the build-up in surplus that’s

occurred. It will take 12 to 18 months to work through the oil that’s now being put into

storage.

  • A OPEC+ production cut deal would help benchmark prices, help future prices. But it

won’t help physical prices. That’s where we are going to continue to feel pain. A lot of

pain.

○ Jobless numbers were 6.6 million new claims last week alone. That’s economy

wide but I’m afraid a lot of those are our people.

  • Where we are headed is likely going to be $45 average Brent oil prices, $35 to $40 WTI.

○ Over the long term, OPEC and Russia will be on top of the market as exploration

of new frontiers go undiscovered because of starved exploration budgets.

○ Higher cost shale is going to be in trouble. Oil sands are closed. The frontier

independents that are so important in opening new plays are at highest risk. They

won’t be able to get credit.

Trump Administration

  • The longer the price crisis lasts, the higher the potential that Congress will push for action

that could have unintended consequences that further destabilizes the market.

  • President Trump is getting pressure from all sides. His normal instinct is to cheer low

gasoline prices because it is good for American consumers.

○ But this is an unprecedented event and the bigger risk is not rising gas prices but

Great Depression level unemployment numbers and economic stasis. The

President likes to make things happen, but this may be beyond the power of his

Twitter account – which has been surprisingly low key lately.

○ He’s watching what the Saudis and Russia are saying and will weigh in if he

thinks they aren’t moving fast enough or in the right direction.

  • Senators from oil-producing states are pressing the president for a number of measures to

stem the bleeding, including a call for a ban on US imports of OPEC crude, threatening to

pull military support for Saudi Arabia, and pushing for tariffs on Saudi oil.

○ Sens. Cramer (ND) and Sullivan (Alaska) have set a call with Saudi Arabia on

Tuesday.

  • Trump could seek to reimpose the ban on oil exports in place in the United States for

decades after the Arab oil embargo but was lifted in 2015 after intense industry lobbying.

○ U.S. crude exports averaged 3.15 million barrels a day in March.

○ Such a move could end up hurting the industry more than it helps, flooding

domestic markets and pushing down physical oil prices even if it might boost

benchmark oil futures. And such an excessive cut to market access would be seen

as overzealous by the industry.

  • Interior is not considering royalty relief. I know that’s been rumored, but I don’t get the

sense that it was ever really under serious consideration at the Secretary’s office.

  • DOE is turning the SPR into a Public Storage, which is something. But it would be better

for the industry and better for taxpayers if DOE bought the oil outright.

○ Buy low, sell high, use for pork. That has to have some appeal in Congress, which

is always looking for pay-fors for pet projects. Congress should provide the $3

billion to fill the SPR.

○ The SPR has the capacity to store 713.5 million barrels of crude and is already

almost full, as it already contains 634.9 million barrels of crude.

  • The biggest help from the feds so far – besides the pressure to get the Saudis and Russians

talking again – has been the SBA forgivable loans that are available to all employers. If

you haven’t taken advantage of them yet, you should.

Available storage

  • At the heart of the storage problem is the sudden drop in road fuels demand. US gasoline

demand is set to decline by an unprecedented 3.3 million bpd in April. The astonishing

gasoline demand collapse will push refiners to cut runs and will trigger shut-downs.

Rystad estimates that US refinery runs in April will fall by 3.8 million bpd to 12.6 million

bpd.

○ Commercial crude stocks may build by nearly 90 million barrels in April 2020 as

refiners dramatically reduce runs and producers bring about 12.7 million bpd of

supply to market.

○ Total commercial storage in the US is about 653.4 million barrels, or some 780

million barrels including pipeline fills and crude-in-transit. At the end of March,

469.2 million barrels of oil were already in stock.

○ Crude builds in April will reduce available crude capacity by a third, leaving

about 200 million barrels of storage capacity (or two more months at the same

filling rate). In practice, available crude capacity might be closer to 150 million

barrels.

Rationalization through bankruptcy and mergers and acquisitions.

  • There will be bankruptcies. There will be mergers.
  • Larger diversified operators, which have multiple cash-generating engines and are more

resistant to volatile commodity prices, are in the best position to weather this crisis.

  • There are 74 public independents operating in the US, Sheffield at Pioneer estimates that

their number could fall to 10. Let’s hope the shakeout is not that bad.

  • We were already under intense pressure from investors to improve efficiency and capital

discipline. Whenever the producers look to cut, they look to us. Margins are razor-thin to

nonexistent.

○ Nine out of 10 shale companies had a negative cash flow at the beginning of the

year. “The gap between capex and CFO has reached a staggering $4.7 billion.

This implies tremendous overspend, the likes of which have not been seen since

the third quarter of 2017” – Rystad Energy.

○ 40% of shale players could go bust if prices don’t climb back into shale’s average

break-even price of around $45 a barrel.

○ A new report from the Kansas City Fed finds that activity “decreased at a steep

pace in the first quarter of 2020.”Participants in the survey expect, on average,

that 61% of firms will stay solvent in the next year if prices were at $30, and that

only moves to 64% at $40.

  • The upside is that, just like 2016, the companies still standing when prices rebound, will

be stronger and more resilient. The industry will be stronger. The rock is still going to be

there and we’ll be there to work it. I understand that sentiment may not be all that

comforting to companies facing an immediate liquidity challenge and no credit available.

  • Oil markets and, therefore, the world economy may look quite different. Shale plays will

continue to supply more than half of U.S. oil but total output will be lower. Many

companies will disappear. Neither production or prices may return to 2018 levels for

many years.

○ Looked at another way, though, there will be opportunities for companies with

capital to invest in distressed assets.

  • Other potential upside: Gas could be the next growth market for oilfield service

companies. You are going to have higher gas prices because of far less associated gas

production. That’s positive for the shale industry long term.

○ The impact of a doubling of natural gas prices should not be underestimated on

the health of the U.S. oil industry. While America’s independent producers

account for 83% of the country’s oil production, they account for an even greater

share (90%) of its gas output.

○ Will it completely offset the impact of low oil prices? No. But considering that

independent producers provide over 4.5 million American jobs, the effect of a

tighter gas market and higher prices will play an essential role as U.S. energy

firms recover from the devastating economic effects of the coronavirus.