The last barrel

On April 20, panicked selling of oil futures—initiated by plummeting demand caused by COVID-19 and fears over dwindling U.S. storage capacity—triggered a 300% drop in the WTI futures price to minus $37.63/bbl. The negative price event, and subsequent collapse of spot prices, has forced U.S. operators to grudgingly shut in wells and reduce output, albeit solely for economic reasons. This marks the first time that U.S. producers, with their “every-man-for-himself” mentality, have made an effort to help balance markets after increasing output at the expense of Russia and Saudi Arabia, which were cutting production to support prices.

And despite clearly stated statutory roles to “prevent waste” and “protect correlative rights,” the Texas Railroad Commission (RRC) and Oklahoma Corporation Commission both failed to suppress production during the crisis, to bolster crude benchmarks and limit job losses.

Operators forced to respond. U.S. drilling activity fell to an all-time low of 284 rigs during the week of June 5, with operators stacking 318 units since April 9. That’s 657 rigs less than on June 7, 2019, and it was the fifth consecutive week that the U.S. count fell to a new record low. Analysts at JPMorgan projected that the U.S. would reduce output by 1.5 MMbopd by June, but in mid-May, production was already down by at least that much, and it continues to decline. Consultancy IHS Markit said that U.S. producers were in the process of curtailing 1.75 MMbopd of existing output by June, due to operating cash losses, lack of demand, limited storage capacity and an unwillingness to sell resources at low prices.

The declines include 758,000 bopd by ConocoPhillips, Continental Resources and Chevron, according to Bloomberg. In the Bakken, operators have reduced output by 500,000 bopd, while daily production from Alaska’s North Slope is down 100,000 bopd from early March. And Continental has additional plans to reduce its overall output by 70% and draw $1.13 billion on its credit facilities, according to a regulatory filing. EOG Resources said that it’s cutting approximately 25% of its production and canceling 40% of new wells that it had planned to bring online this year.

Analysts predict U.S. shut-ins will reach 2.0 MMbopd in June, including NGLs, with Permian-focused producers driving 42% of the reductions. Permian output is forecast to drop 87,000 bopd in June, to 4.29 MMbopd, according to EIA. Some producers expect that the June cuts may eventually increase, depending on the prevailing oil price, but oil volumes should mostly return to pre-reduction levels during third-quarter 2020.

Lingering effects. However, analysts at IHS Markit predict output will continue to decline for the rest of the year and into 2021, as the industry works to draw down excess supply. “The Permian might rebound faster because of a better resource base,” said Kurt Barrow at IHS Markit. The number of drilled-but-uncompleted wells in the Permian increased 28, to 3,464 in April. That is the highest total since September and is further evidence that producers still have stranded assets that require attention, once the recovery takes hold. “But there is still a risk of a resurgence in the virus that will prompt large-scale lockdowns that will reverse that growth,” Barrow concluded.

Oil sands react. Canada also slashed investment and production from its oil sand operations beyond expectations. IHS Markit estimated capital expenditure cuts in Western Canada’s oil and gas sector would total over $6 billion, but as the reality of record low oil prices set in, producers cut spending by more than $8.4 billion. By May 8, more than 700,000 bopd of output reductions had been announced, with Canadian Natural Resources, Suncor Energy and Husky Energy all reducing heavy oil output. IHS Markit predicts that western Canada’s output my decline by more than 1.0 MMbopd in the second quarter, compared to fourth-quarter 2019.

Executives at Plains All American Pipeline said that shut-ins in the U.S. and Canada, combined, are between 3.5 MMbopd to 4.5 MMbopd. “We assume June-July will be the trough, with some activity resumption in August,” said Plains V.P. Jeremy Goebel. “From a big picture point of view, the worst is behind us, and the market is moving toward re-balancing,” said Daniel Ghali, a TD Securities commodity strategist.

Crude inventories still at record highs. Despite production declines in North America, U.S. crude stockpiles are still close to record highs. A fleet of 30 Saudi oil tankers, with more than 50 MMbbl of oil, is starting to arrive along the U.S. Gulf and Pacific coasts. And as oil prices start to climb, we can expect shale producers to open the taps, as soon as they can make a profit, putting downward pressure on the struggling recovery. Crude benchmarks will not recover to pre-COVID-19 levels during the second half of the year, as the excessive build-up in inventories must be worked down, according to a European consulting firm. Although crude stockpiles will be reduced gradually over the next 12 months, all bets hinge on avoiding a second wave of the coronavirus, which is still a major concern as countries around the world remove lockdowns.

What really happened? In April, President Trump helped to broker an end to the global oil-price war being waged by Russia and Saudi Arabia. The Trump administration assured world leaders that America’s shale operators would throttle back production. U.S. Secretary of Energy Dan Brouillette added that the U.S. would cut production by about 2.0 MMbopd this year. Despite the “win-at-any-cost” mentality displayed by most companies, U.S. production is starting to decline. While many will take credit for the reductions, the real question remains, is the decline a result of responsible management by our industry leaders, or is it a consequence of economic necessity? Based on past experience, I suspect the latter is closest to the truth.

About the Authors

Craig Fleming

World Oil

Craig Fleming Craig.Fleming@WorldOil.com