Opinion

Will there be a bailout for the hard-pressed US shale industry?

As US E&Ps are battered by plunging oil prices, the Trump administration is considering offering them financial support

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Lehman Brothers, the US investment bank, filed for bankruptcy in the small hours of Monday morning on 15 September, 2008. Just four days later, with the markets in turmoil, Treasury secretary Hank Paulson had to launch the Troubled Asset Relief Program, the start of a series of government bailouts for financial institutions and other industries including the car-makers.

As stock markets and oil prices have plunged this week, plans for another round of bailouts have been rising up the political agenda. The Trump administration is weighing up the possibility of measures to support the US oil industry, the Washington Post and The Hill reported, as part of a broader effort to mitigate the economic impact of the new coronavirus outbreak.

There are several different forms such assistance for oil companies could take, including low-interest loans, crude purchases for the Strategic Petroleum Reserve, and restrictions on oil imports. Harold Hamm, founder and executive chairman of Continental Resources, argued that Saudi Arabia and Russia were “dumping” low-priced oil on the US market and should face countervailing duties.

Oil is one of the industries that has been hit the most immediately by the coronavirus outbreak. If crude prices stay at around their current levels, with Brent at about US$33 a barrel and WTI at about US$31, the financial strain on the US E&P sector will become extreme. Rob Clarke, Wood Mackenzie’s research director for the Lower 48 upstream, predicted “fast and brutal” cuts to development activity, “made possible by tight oil’s unique flexibility”. 

Already several US companies have been announcing cutbacks in drilling and completions. Diamondback Energy reported before the market had even opened on Monday morning that it planned to go from nine completion crews to six, and was dropping three rigs from its previous plan to run an average of 20-23 in 2020. Marathon Oil said on Tuesday it was cutting its planned capital spending in 2020 by $500 million to $1.9 billion, representing a reduction of about 30% from its actual spending in 2019. Chevron told Reuters it was “reviewing alternatives to reduce capital expenditures”, in order to “lower short-term production and preserve long-term value”. At least one company, Parsley Energy, has written to suppliers of oilfield equipment and services seeking steep reductions in its costs.

In the last downturn the oil and gas production and services industries lost about 180,000 jobs, from the peak in September 2014 to the trough in October 2016, and the administration will certainly want to avoid such a damaging outcome if it can. Some energy-producing states will be hit particularly hard, as Nikos Tsafos for the Center for Strategic and International Studies showed in an analysis of the downturn of 2014-16. Louisiana, West Virginia and Alaska have still not fully recovered from the hit they took then. Texas actually fared relatively well in that downturn, thanks to the strength of its non-oil economy. In the Texas Monthly, however, Evan Mintz warned that “Houston is not prepared for the oil bust” that is coming.

Despite these worrying signs, there are good reasons to think that a “shale bailout” for the oil industry is not imminent. Administering such a programme would be complex: there are about 9,000 independent oil and gas producers in the US, according to the Independent Petroleum Association of America. Deciding on eligibility would be tricky. Shares in gas-focused producers such as Cabot Oil & Gas and Range Resources have been relatively resilient this week. Natural gas prices have held up, because a slowdown in oil production growth is expected to mean a slowdown in the flood of associated gas expected to hit the US market. So should those gas-focused companies be eligible for support too?

Another reason to be wary of providing low-cost government-backed financing is that it would distort both the oil market and capital markets, helping the more heavily indebted companies more than their less profligate rivals. Liam Denning of Bloomberg described the idea as not just socialism, but “the Soviet-grade tractor-quota good stuff.”

Many people in the industry do not want government help. Mike Sommers, president of the American Petroleum Institute, told Houston Public Media: “We don’t think that involving the federal government in some kind of a bailout at this point is the right thing to do for the industry or for the American economy.” The best thing President Donald Trump could do would be “to engage with the leaders of Saudi Arabia and Russia to make sure that these markets are not oversupplied,” he added.

At the time of writing, Nancy Pelosi, speaker of the House of Representatives, and Steven Mnuchin, the Treasury secretary, were debating the details of a plan to help mitigate the impact of the coronavirus, without provisions aimed specifically at oil or any other industries. But if the crisis deepens, then financial support for US businesses, including oil companies, is likely to gather momentum, despite all the drawbacks.

No signs of a quick end to the oil price war

The cause of this week’s plummeting oil prices was the failure of the ministers from the OPEC+ group of countries to agree production cuts when they met in Vienna last week. OPEC members, led by Saudi Arabia, had hoped to get their non-OPEC allies, led by Russia, to commit to a 1.5 million barrel a day reduction in output until the end of the year, but the talks went so badly that both sides emerged suggesting they would actually increase their production.

Saudi Aramco said on Tuesday that in April it would raise oil supplies to customers to 12.3 million barrels a day, more than its maximum production capacity of 12 million b/d. Much of this will initially come from inventories. The next day the Saudi government stepped up the pressure, saying it wanted Saudi Aramco’s production capacity to be raised to 13 million b/d. Saudi Arabia is sending cheap barrels to refineries from Europe to India in an attempt to displace Russian crude.

John Kemp of Reuters suggested Saudi Arabia was using “shock tactics” to try to bring its dispute with Russia to a quick resolution. However, Russia is signalling that its government is not yet ready to change its mind about joining in output cuts. Pavel Sorokin, Russia's deputy energy minister, told Reuters that oil producers “cannot fight a falling demand situation”. He added: “It is very easy to get caught in a circle when, by cutting once, you get into an even... worse situation in say two weeks: oil prices would shortly bounce back before falling again as demand continued to fall.”

A previously arranged meeting of the OPEC+ group’s advisory Joint Technical Committee, scheduled for 18 March, now looks unlikely to go ahead.

Some commentators have suggested that the slump in oil prices should soon start to boost demand, but Wood Mackenzie’s analysts doubt it. The containment measures being put in place to curb the coronavirus outbreak, with shows and sports events cancelled, and schools and workplaces closed, are having an increasingly serious effect on the world economy.

The WoodMac macro oils team expects China’s demand to show “material recovery” in the second quarter, even if it does not quite get back to normal, but “the impact of Covid-19 is looking increasingly dire in countries outside of China”. In the past few days we have heard about a further blow to fuel demand in Trump’s new restrictions on travel from many European countries to the US. Mark Williams, Wood Mackenzie’s principal analyst for refining, estimated that the restrictions could mean that demand for jet fuel drops by between 200,000-250,000 b/d.

Coronavirus updates

Wood Mackenzie has created a special page bringing together all our latest research on the impact of the coronavirus outbreak. It will be updated regularly.

In brief

Elon Musk is looking across middle America for a site for another Gigafactory, this time to build his new futuristic-looking electric pickup, the Cybertruck. Nashville, Tennessee, is said to be one of the contenders to attract the investment, as the state is developing a cluster in electric vehicle manufacturing.

The low cost of renewable energy creates opportunities for US utilities to cut emissions while saving money and increasing profits.

Developers around the world risk wasting $600 billion in new coal-fired power plants that will be uneconomic because renewable energy will be cheaper, according to the Carbon Tracker Initiative, a think-tank.

Meanwhile, underwriters are under pressure to stop insuring coal-fired plants.

Virginia has become the first southern state in the US to set a goal of sourcing 100% of its electricity from renewables by 2050.

In its budget this week, the UK government pledged about £800m (US$1bn) for its plan to set up two clusters of infrastructure for carbon capture and storage.

The US, the EU, Canada and six European countries have held talks to discuss their shared concerns about Mexico’s energy policies under President Andres Manuel Lopez Obrador. He is trying to increase the state’s role in the industry.

And finally: many of the world’s most powerful computers are deployed for energy-related applications, and The US Department of Energy is now being promised one with record-breaking speed. The department’s Lawrence Livermore National Laboratory in California is scheduled to take delivery in 2023 of a new Hewlett Packard supercomputer named El Capitan, which is said to be ten times faster than today’s most powerful machines.

El Capitan is not intended for any uses related to energy production, however. It will support the work of the DoE’s National Nuclear Security Administration, maintaining the safety and effectiveness of the US nuclear weapons stockpile.

Other views

Simon Flowers — Guyana: global oil’s new king of the heap

Simon Flowers — Seven days that shook the world

Gavin Thompson — Asia’s central banks are getting serious on sustainability

Nick Butler — Is 2020 the year for regime change in Venezuela?

Morgan Bazilian and Samantha Gross — Covid-19 is a reminder that interconnectivity is unavoidable

Robin Mills — Riyadh gathers OPEC partners for oil price war with Russia

Joshua Rhodes — Now is the time to invest in energy infrastructure

Quote of the week

“These attempts by state actors to manipulate and shock oil markets reinforce the importance of the role of the United States as a reliable energy supplier to partners and allies around the world.  The United States, as the world’s largest producer of oil and gas, can and will withstand this volatility.”— Shaylyn Hynes, spokeswoman for the US Department of Energy, criticised the plans of OPEC and Russia to increase production after they failed to reach an agreement on cuts.

Chart of the week

This comes from a report on energy storage in the US published by Wood Mackenzie’s power and renewables team. The bars show the rise in new installations of storage capacity, which hit new records in the final quarter of 2019 and over the year as a whole. As Julian Spector of Greentech Media pointed out, utilities are starting to see real value in battery storage for backing up variable renewables and providing services to the grid, while “an unprecedented number of homeowners seek solar-battery combinations to keep the lights on in an outage.”