The Unpredictable Oil Business Fools The Experts Again
As with seemingly every other aspect of the COVID-19 pandemic, the fallout and recovery related to the U.S. oil and gas industry is not progressing as the experts had predicted. Given the generally unpredictable nature of the oil business, this really should not be all that surprising. After all, if it was predictable, we’d all be rich oil barons.
A great example of this lack of predictability is today’s trading on the June contract for West Texas Intermediate, the standard index price for domestic crude sales. Just a few weeks ago, speculation was rampant that the price for that contract could fall into negative territory today, which is the final day of trading before we move to the July contract. That was what happened on the last day of trading on the May contract, after all, as fears that global crude storage would be full by right about now pervaded the markets.
But here we are on May 19, and those fears have pretty much abated, with WTI trading above $32 per barrel, a level not seen since March. The reasons why are obvious: Global demand is recovering more rapidly than the experts were predicting at the first of this month, while supply is commensurately dropping more quickly than expected.
China has restarted its economy so rapidly that its domestic demand is now above 13 million barrels of oil per day (bopd), almost equaling its level of a year ago. With the U.S. and many European nations also restarting their economies, some analysts now expect global demand to recover to within 5% of its January 1, 2020 level by the end of the year.
On the supply side, the markets have seen encouraging news about strong compliance by the OPEC+ countries with their deal to cut production by 9.7 million bopd starting May 1, and indications that the group could extend that level of reductions longer than initially anticipated. That deal was enhanced last week by Saudi Arabia, which announced it would cut an additional 1 million bopd from its own production in June.
As I speculated based on anecdotal information last week, we also now have data from the U.S. Energy Information Administration indicating that U.S. producers have already dramatically cut their own production by as much as 2.4 million bopd. That is a stunning drop in such a short period of time.
Taken altogether, these developments have essentially ended fears about global supply becoming completely full, at least for now. My bet is that we will now begin seeing projections that the market will be re-balanced significantly sooner than than the late 3rd quarter/early 4th quarter predictions we have seen thus far.
Here is the thing everyone needs to understand: As things stand today, no one should expect to see any sort of “V-shaped recovery” in U.S. oil production, as some are predicting. There are several reasons why you should instead anticipate a “U-shaped recovery” process, with the horizontal piece of that “U” being fairly extended.
• The decimation of the nation’s frac spreads. The latest data from Primary Vision indicates that active frac spreads in the U.S. have collapsed from 358 on January 17 to just 45 today.
• That 87% cut in frac spreads means that service companies have laid off thousands of men and women who staff those crews, many of whom will never be willing to work in the industry again. Companies like Halliburton and Schlumberger won’t be able to just re-man and restart those crews on a moment’s notice – they will have to hire and train thousands. That will take time.
• The same is true for the drilling business. The Enverus Daily Rig Count hit 357 on Monday, its lowest level ever. That means lots of new hiring and training in that segment of the business as well before it can recover to anything close to previous levels.
• We also have to recognize that many upstream companies of all sizes have dramatically scaled back their capital budgets for the remainder of this year. Most of those companies completed their mid-year updates during April and the first part of this month, during the depth of the price depression. So those 2nd-half budgets are baked into the cake for the rest of the year, and significantly revising them upwards in this uncertain environment would be difficult to achieve.
• Then you have the high decline rates inherent to shale wells. This dramatic drop in drilling and fracking levels means the industry is not drilling the number of new wells necessary to maintain production levels.
All of those current overriding factors mean you should expect overall U.S. production to continue falling through the remainder of 2020. At least, that is, until those factors change again, something we know they will do.