Supply-Demand Balance Needed To Restore Oil Market
In the wake of an unprecedented sell-off in the crude oil market, the only response to balancing global markets is to reduce supply.
How many times can you say "unprecedented?" The COVID-19 pandemic has resulted in a massive reduction in global oil demand, yet production cuts haven't kept pace. As predicted, the world is running out of oil storage capacity and that reality is now being reflected in crude prices. It really seems like an understatement to say the recent plunge in WTI prompt futures contract price trading near negative $40/bbl was "unprecedented", but so it was.
Until supply and demand are back in balance, oil will not only remain below breakeven drilling prices, but will be below the cost of operating many existing wells. So, what needs to happen to restore oil markets?
"Until supply and demand are back in balance, oil will not only remain below breakeven drilling prices, but will be below the cost of operating many existing wells."
Although part of the problem has been oversupply caused by the rapid growth in U.S. production over the last several years, and the unwillingness of OPEC+ to continue to cut their production to stabilize prices, that's insignificant compared to the demand destruction caused by the pandemic. Until the public health situation is under control, through improved testing, treatment and ultimately a vaccine, we can expect people to travel much less and demand less fuel. Oil demand will return, hopefully sooner than later, but until then the only response to balancing global markets is to reduce supply.
In Texas (which accounts for 40% of U.S. oil production), it’s the Railroad Commission's responsibility (among other things) to prevent the waste of resources. Despite pleas from many industry leaders at the Commission's virtual meeting regarding prorationing last week, it doesn't seem likely to me that they’ll use their authority to reduce production to help stabilize prices.
We should expect to see operators take immediate action to reduce production, however. The rig count will continue to fall and operators will begin shutting in or choking back wells. Much of this will be in response to the simple fact that there’s no place for all of this production to go so it’ll need to stay in the ground until demand is restored. The downside to this limited and uncoordinated response is that it may not reduce supply enough to quickly stabilize prices at a level that allows many companies to continue operating. Unfortunately, the related job losses will likely lead to further economic damage.
About the Author:
Steve Hendrickson is the President of Ralph E. Davis Associates, an Opportune LLP company. Steve has over 30 years of professional leadership experience in the energy industry with a proven track record of adding value through acquisitions, development and operations. In addition, Steve possesses extensive knowledge of petroleum economics, energy finance, reserves reporting and data management, and has deep expertise in reservoir engineering, production engineering and technical evaluations. Steve is a licensed professional engineer in the state of Texas and holds an M.S. in Finance from the University of Houston and a B.S. in Chemical Engineering from The University of Texas at Austin. He currently serves as a board member of the Society of Petroleum Evaluation Engineers and is a registered FINRA representative.