Russia Yanks A Leg From U.S. Shale’s Three-Legged Stool
For the last two-plus years, the U.S. shale industry has been able to continue its oil boom thanks to the existence of a figurative 3-legged stool of support. Those three legs have been easily identifiable:
• The ability to legally export crude oil to other countries;
• An ongoing license to build pipelines and conduct fracking operations; and
• The continuation of the OPEC+ deal limiting exports by other oil producing nations.
So long as all three legs of that stool remained in place, crude prices have remained healthy enough to allow shale operators to continue drilling wells, increase overall U.S. production and for the most part remain fairly profitable. But, as with any stool, the removal of any one of the legs upsets an undeniably delicate balance, potentially spelling disaster for anyone sitting atop it.
On Friday, Moscow yanked one of the three legs from the stool by refusing to agree to additional export cuts that had been unilaterally proposed by the OPEC member nations on Thursday without Russian representatives in the room. Crude prices immediately collapsed, experiencing their worst day in more than 5 years with a drop of 10%.
Russia is the largest “non-OPEC” participant in the so-called OPEC+ arrangement that that has resulted in the withholding of production and exports of crude by these countries since the plan was first implemented in December, 2017. The OPEC+ deal was first conceived in the summer of that year, after Brent prices had dropped into the mid-$40s during June. Since its implementation, the agreement to limit exports has helped to keep the market in balance despite rapidly-growing U.S. shale production, and had successfully supported a Brent price above $60 per barrel – and often above $70 – prior to the recent impacts of the coronavirus.
On Thursday the OPEC nations proposed additional cuts that would have taken an additional 1.5 million barrels of oil per day off of the market, 1 million of which would have been born by the OPEC members, with the remaining 500,000 in cuts obligated to Russia and its fellow non-OPEC participants. On Friday, though, Russian Energy Minister Alexander Novak returned to Vienna and informed the group that his country would not agree to any further cuts.
While some initial media reports indicated Russia had agreed to extend the pre-existing export limits through the second quarter of this year, Reuters quoted Novak as saying “Considering the decision taken today, from April 1 of this year onwards, neither we nor any OPEC or non-OPEC country is required to make (oil) output cuts.”
Manish Raj, chief financial officer at Velandera Energy, told Marketwatch that “Russia is certainly betting that price crash will cause U.S. production to crash, helping restore its dominance.” If that is really Moscow’s thought process, it is likely to be disappointed. Saudi Arabia already attempted a similar strategy to kill U.S. shale, flooding the market with crude in 2014 to create an enormous glut and drive down prices in an effort to reclaim market share.
Such a strategy demonstrates a misunderstanding of American bankruptcy laws. While the crash in oil prices that began in late 2014 did ultimately result in hundreds of shale producers declaring Chapter 11 bankruptcy, the net result of that process is that most of those companies reorganize themselves and come back with far less debt load. The strategy also fails to recognize that most producers have already put hedges in place for most of their equity production through the remainder of 2020 and beyond.
As a result of these realities, from the time the Saudis embarked on their strategy to reclaim market share in mid-2014 through August, 2017, when they initiated talks with Russia related to the OPEC+ agreement, overall U.S. production actually rose by half a million barrels per day. That increase in production came during a period of time in which more than 200 upstream companies went through the bankruptcy process.
So, if Moscow’s plan here really is to try to “kill” the U.S. shale industry, Novak and other leaders should be prepared to sustain it for a long and painful haul.
It should be noted that Novak also said on Friday that Russia would continue to cooperate with other OPEC+ nations in monitoring market conditions, providing some hope that a compromise extension of the exports limitation agreement could be forthcoming in the weeks to come. Russia has in the past rejected proposed cuts only to quickly agree to an alternative plan.
But, for the time being, U.S. shale’s stool of support is missing one of its legs, and the resulting ride will be very bumpy.