Only a few months ago, Donald Trump was proclaiming a “golden era” of American energy dominance as the US produced more crude oil than any other country in the world. Now, the president is vowing to use the powers of the federal government help the sector back on its feet.
The precipitating blow came on Monday when the price of benchmark West Texas Intermediate fell below zero. But even before Monday’s crash, the 70 per cent drop in the price of WTI since January — a reaction to plummeting energy demand caused by the spread of the coronavirus — had begun to hobble the US oil business.
ExxonMobil, Chevron, ConocoPhillips, Occidental Petroleum and others have all slashed spending. Independent shale producers such as Continental Resources and Parsley Energy have idled rigs and begun shutting wells. US production was almost 13m barrels a day earlier this year, but could be 2m to 3m b/d fewer by the end of 2020, according to Dan Brouillette, the US secretary of energy.
Analysts say bankruptcies and mass job losses are inevitable, as producers retreat in the face of $20-a-barrel oil. “At these prices, the entire industry is underwater,” said David Winans, credit analyst for PGIM Fixed Income.
On Tuesday the US president promised on Twitter that he would “never let the great US oil and gas industry down” and said his administration was formulating a “plan which will make funds available so that these very important companies and jobs will be secured long into the future”.
Four main methods of helping the industry have been discussed.
Tap foreign buyers and suppliers
Mr Trump helped push through the Opec+ supply deal between Saudi Arabia, Russia and other producers on April 12 — the biggest cuts ever announced by the cartel. The deal has flopped. The cuts, while huge in historical terms, were a “shrug in a bucket” compared with the 30 per cent or so collapse in global oil demand, said Jamie Webster of Boston Consulting Group.
So a first step for Mr Trump will be to push Saudi Arabia to cut again. The problem is that more Opec supply curbs — even if they could be agreed and observed — are unlikely to fix a demand-side problem.
The American Exploration & Production Council, a shale lobby group, proposes another step — that the White House push China to buy more US oil. At its peak in 2017 the US exported about 470,000 b/d to the country, far less than the 1.3m b/d drop in US demand expected by the government this year. In a world awash with crude, however, China has many other cheap supply options.
Tariffs on foreign oil suppliers also remain on the table, said analysts briefed on the administration’s thinking. These have support from some oil executives, such as Mr Trump’s friend Harold Hamm, head of Continental Resources. But most other companies and the American Petroleum Institute, a powerful lobby group, oppose the idea. Tariffs would cause problems for US refiners set up to process foreign grades of oil.
Fill baby fill
Plummeting demand is the source of the problem, so two broad ideas to create demand have emerged.
First, the federal government could buy oil to store in the Strategic Petroleum Reserve — an emergency stockpile set up in the 1970s. Mr Trump first proposed this several weeks ago, but congressional Democrats refused to fund the purchases without equivalent money spent on green energy.
Mr Trump revisited the idea on Monday evening, saying there was space to soak up 75m barrels. Analysts say the US overproduction is running at about 2m b/d, so this would clean up some of the glut.
But oil prices ultimately reflect global balances and 75m barrels is just over two days’ worth of global demand, which itself may be down by 35m b/d, according to trading house Trafigura.
The federal government could also find other places to store oil — perhaps salt caverns along the Gulf Coast that now house natural gas and other fuels, said Kevin Book of Clearview Energy Partners.
In theory, the SPR, which has capacity for almost 800m barrels, could be expanded to 1bn barrels. This has been authorised, but funding has not been. Mr Trump has asked Mr Brouillette to find more storage. But commercial capacity is close to full — hence the collapsing price.
“If there were any good storage answers they’d have one by now,” said Mr Book.
‘Shut and swap’
A second idea gaining favour among banks and hedge funds is for the government to buy oil that producers leave in the ground until prices recover. At that point, the producers extract and sell the oil for a higher price than the government paid them, and then repay the government.
It is a way for the government to keep companies’ cash flow intact while also curbing overproduction. The government could charge interest at the Federal Reserve’s base rate and the taxpayer would eventually be repaid in full, said Greg Pardy at RBC Capital Markets.
Mr Pardy dubs this idea “shut and swap” and says its real strength is that the industry “needs revenue right now”. Other bailout plans, or tax credits, would not deliver cash flow quickly enough.
Shale executives also hope distressed producers will be offered some relief from Treasury secretary Steven Mnuchin’s $450bn war chest to prop up the US economy and companies struggling in the face of the coronavirus pandemic.
For Mr Trump, such support is justifiable because he sees the US oil surge of recent years as a “strategic capability” that needs to be defended, said Clearview’s Mr Book.
Let it rip
The other possible response is precarious — or even fatal — for small producers, but supported by the API and other US supermajors such as ExxonMobil and Chevron.
This is to let market forces rule.
The price collapse would be allowed to winnow out the field of producers and ration supply.
It would also guarantee job losses, bankruptcies and a rapid consolidation of the shale business as deep-pocketed producers would buy smaller independent companies and enforce new efficiencies.
Mr Trump must decide which kind of shale patch he prefers.