U.S. Oil Producers face existential threat amid unprecedented demand decline

The U.S. oil industry is in a slump the likes of which it hasn’t seen in 100 years, and many in the industry are wondering if there will be any coming back from the bust this time.

In just a few months, the industry became the second-smallest segment of the Standard & Poor’s 500 Index, with its weighting down 80% during the past decade. While the COVID-19 pandemic has raised concerns about how quickly demand will recover, the industry’s biggest concern is that investors — who have increasingly become disenchanted with fossil fuels in general and producers’ recent poor performance in particular — may never return.

The oil prices in the past month and the flow of capital out of the business have raised the concern that, as one industry executive recently told CNBC, “we will disappear as an industry.”

The symbol of just how bad things have gotten came in late April, when prices for West Texas Intermediate crude, the U.S. benchmark, briefly dropped to negative $38 a barrel. It started the year above $60. The negative pricing only lasted for a few hours, but WTI has never traded for less than zero, and the psychological impact what happened Monday continues to cast a pall over the market.

The nationwide lockdown in response to the coronavirus pandemic has gutted oil demand, which some forecasters predicted would decline globally by as much as 29 million barrels a day. In the U.S., producers are pumping 2 million barrels a day more oil from the ground than our refineries are processing (even though U.S. refiners don’t all process oil from U.S. fields).

Gasoline is selling for less than it has in more than a decade. Typically, low prices at the pump stimulate the economy, but stay-at-home orders have kept most cars in the garage.

In the short term, bankruptcies are rising. Chesapeake Energy, stumbling under a $9 billion debt load, recently agreed to prepay $25 million in incentive compensation to 21 top executives to keep them at the company while it prepares a bankruptcy filing. Whiting Petroleum and Diamond Offshore Drilling made similar moves last month ahead of their bankruptcies.

Oilfield services company Weatherford International, which emerged from bankruptcy protection just months ago, is already back in the red. The company lost $966 million in the first three months of the year.

The losses extend to the majors as well. Exxon Mobil reported its first quarterly loss in more than 30 years. Exxon, Chevron and ConocoPhillips plan to cut production by as much as 660,000 barrels a day by the end of June.

Producers that have managed to stave off bankruptcy have begun voluntarily shutting in production, especially in the prolific Permian Basin of West Texas. Last month, the Texas Railroad Commission, which regulates the state’s oil and gas industry, voted against implementing production controls, a power it hasn’t used since the early 1970s. It considered the action at the behest of several large Permian producers.

While producers are racing to turn off the pumps in West Texas, in the Gulf of Mexico companies are pulling back as well, a more significant sign that U.S. producers expect a lengthy bust.

"We are seeing a level of demand destruction and oil industry downturn that in the past occurred over a period of years now happening over a period of days." Railroad Commissioner Ryan Sitton said. He noted that tens — and perhaps hundreds — of thousands of jobs could be at stake. “Eventually, those jobs will come back, but they may not come back in the state of Texas and the United States.”

With little help coming from the state, producers may be at a disadvantage in Washington, too. Republican senators from several oil-producing states have claimed that big banks, which are administering federal stimulus loans to businesses, are “discriminating” against fossil fuel producers. In a letter to President Trump, three dozen lawmakers urged the administration to take action against big banks that have decided to limit lending to oil and gas companies. The lawmakers claim the banks are bowing to pressure from environmentalists who want the banks to divest of fossil fuel interests.

Not everyone in the Hemisphere, though, is cutting back. Mexico is doubling down, boosting spending for new wells, using new technology to increase production from ageing fields, overhauling six refineries and spending $8 billion to build a new one. President Andrés Manuel López Obrador cut federal spending last year and has been reluctant to boost stimulus programs in the wake of the COVID-19 pandemic. Instead, he’s pouring resources in the state-owned oil company, Petróleos Mexicanos, in hopes that it will become the engine of economic recovery for the nation. The idea, the president said is to “save Pemex in order to save Mexico.” Pemex plans to boost spending this year to $11 billion from $10.8 billion last year and will drill 423 wells — double that of 2019.

Undaunted by the price decline, British petrochemical giant Ineos is moving ahead with the plans to begin fracking two wells in the Austin Chalk formation in central Texas. Ineos bought tens of thousands of acres from a Houston energy company last year and recently filed for permits to drill two horizonal wells. Ineos had previously planned a shale play in the British Isles, but abandoned the project last year amid environmental concerns and began looking for opportunities in the U.S.

Meanwhile, the pandemic is helping renewable energy make inroads. The U.S. is on track to produce more electricity from renewables than coal this year for the first time on record. The milestone represents a dramatic change from just a decade ago, when more than half of all U.S. electricity was generated with coal. Utilities have retired hundreds of coal plants as the price of renewables have declined significantly — 40% for wind and 80% for solar — during that time. Now, the virus outbreak has resulted in a decline in electricity demand, which has accelerated the shuttering of coal plants because they often cost more to operate than renewables or generating plants powered by natural gas.

As bleak as the outlook may seem, some shale producers are already girding for a comeback. Diamondback Energy, which recently announced it would curb production by as much as 15% and laid off most of its fracking crews for the rest of the quarter, said it’s ready to complete wells that were drilled but not fracked as soon as prices return to the $30 a barrel level. Another producer, Parsley Energy, said at $30, it could return wells to production in a week or two.

By mid-May, with the expiration of the June WTI contract looming, prices rallied to $31.74 a barrel. President Trump tweeted “OIL (ENERGY) IS BACK!!!!” In the U.S. Oil Patch, hope seems to flow more readily than oil these days.

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