March 9 was a brutal day for America’s oil and gas industry. Crude oil prices fell to their lowest level since 2014, dipping as low as $30 per barrel, while the market values of many exploration and production companies, large and small, tanked by 20 to 50 percent.
Clearly, the proximate causes of the meltdown were uncertainty about the economic impacts of the rapidly spreading coronavirus and the incipient price war between Saudi Arabia and Russia. But other factors are at play. Oil prices already had been falling because of an excess of supply and slowing global economic growth. Efficiency in energy use and the growth of renewable energy around the world also have tempered the demand for oil.
So, does this mean Armageddon for fossil fuels, or is it just an overdue correction that the industry will weather as it has in the past? What will it mean for America’s shale producers who have made us the world’s No. 1 oil producer, transformed us from a net energy importer into a net energy exporter, and insulated us from the periodic eruptions in the Middle East that threatened America’s energy security for decades?
The Russians believe they have the means to kill the “shale guys.” With foreign currency reserves of $570 billion, more than Saudi Arabia’s, Russia is able to live with $30-per-barrel oil for an extended period. What’s more, depreciation of the ruble will make Russian oil cheaper than Saudi oil, whose currency is tied to the U.S. dollar. Dmitry Kiselev, the director of Russia’s state news agency, recently quipped that “we have a chance not just to produce and sell as much as we need to, but to throw American shale overboard.”
That’s exactly what Saudi Arabia believed in 2014 when it flooded the market with oil in hopes of killing American shale. But it didn’t work then, and it won’t work now. Here’s why.
The International Energy Agency sees oil consumption falling by about 2 million barrels per day this year, because of the economic slowdown — and maybe a global recession — resulting from the coronavirus pandemic. But as the economy recovers, helped by monetary and fiscal stimulus around the world, the demand for energy will resume its upward course.
The U.S. Energy Information Administration recently forecast that world energy consumption will grow nearly 50 percent by the year 2050, at which time oil and natural gas will still account for 56 percent of the total. Demand for natural gas is projected to double by 2050 as gas continues to replace coal in power generation. In short, fossil fuels aren’t going away any time soon.
What Russia doesn’t understand is that America’s energy industry, especially its shale producers, have an uncanny ability to adapt to dramatically lower prices. When prices cratered in 2014 and 2015, asset sales and bankruptcies soared in the oil patch, with highly leveraged companies the most vulnerable. But the industry consolidated, reduced operating expenses and improved drilling efficiency. Before the bust, the convention wisdom was that shale plays needed $60 a barrel to break even. But by 2016, many shale producers were showing positive cash flow at $30 per barrel.
Six years later, we have leaner and more efficient operators in America’s shale plays, especially the Permian Basin in West Texas and the Marcellus in the Northeast. Indeed, we’re producing record levels of oil and natural gas with 50 percent fewer rigs than a decade ago. What is more, many operators have hedged their production at prices between $40 and $50 per barrel through the end of the year.
Also, on the plus side, big oil companies will continue to invest during the down cycle, especially those with long-term projects such as deep-water drilling in the Gulf of Mexico where the payout period is typically decades instead of a few years.
Yes, there will be pain in America’s oil patch this year, with attendant job losses and lower tax revenues. But if the past is prologue, the oil and gas industry will emerge stronger than ever. And if Russia and Saudi Arabia continue their game of chicken, it may be they instead of the “shale guys” who find themselves in bankruptcy.
Bernard L. Weinstein is associate director of the Maguire Energy Institute and adjunct professor of business economics in the Cox School of Business at Southern Methodist University.