The First Victims of the Oil Price War

Yves here. While this post has some useful information about the dynamics of the price war between the Saudis and Russia, it reaches unduly cheery conclusions regarding US shale players. The sector is almost entirely uneconomic even at much higher oil price levels. I struggle to see how “consolidation” would do much at this juncture to lower the cost of development and production.

Confirming my view is a letter sent by reader Alex, embedded below the OilPrice piece, in which two major shale oil players, Pioneer and Parsley, petitioned the Texas Railroad Commission to cut oil production by 20% to address the price collapse. As Alex put it, “Interesting how self proclaimed hard nosed business folks seem to be melting as if hit by a bucket of water by Dorothy with Toto watching.”

Bloomberg reports that the American Petroleum Institute got in a snit about the request, attacking it as “anti-competitive” and “short-sighted”.

By Alex Kimani, a veteran finance writer, investor, engineer and researcher for Originally published at OilPrice

As the oil price war and coronavirus pandemic rage on, it’s becoming increasingly clear that the energy market can remain choppy and irrational longer than entire nations can stay solvent.  Everybody is watching to see which of the leading protagonists between Saudi Arabia and Russia is going to be the first to blink as high supply and low demand threaten to overwhelm available storage facilities. Scores of oil-producing countries have adopted a raft of austerity measures and spending cuts as they attempt to outlive the biggest oil bust in living memory.

Unfortunately, it’s the riskier corners of the global financial markets that will emerge as collateral damage in the ongoing oil price war.

American credit rating agency Moody’s has warned the dramatic plunge in oil prices is likely to cut fiscal revenue and exports for most exposed oil-exporting sovereigns by more than 10 percent of GDP and, consequently, weaken their credit profiles.

Russia: Most Resilient

According to Moody’s, the sovereigns most vulnerable to low oil prices in the 2020-21 period are those with the highest reliance on hydrocarbons for fiscal exports and revenues coupled with a limited capacity to adjust.

The credit agency says the most vulnerable sovereigns are Oman, Iraq, Bahrain, and Angola due to their limited capacity to adjust to external shocks. These nations could see a decline in fiscal revenue in the range of 4-8 percent of GDP if low oil prices persist.

The vast majority of Gulf Arab states are unable to balance their budgets with oil prices of $40 per barrel, let alone the current $20/barrel level. These developing economies are especially vulnerable due to ongoing massive cash outflows, with investors continuing to liquidate emerging-market assets.

In contrast, Russia, Saudi Arabia, Qatar, Azerbaijan, and Kazakhstan are seen as being less vulnerable, with expected declines in fiscal revenue and exports of less than 3% of GDP.

Interestingly, Moody’s analysts concur with a previous opinion piece, which argues that Russia has the upper hand in the oil price war.

Moody’s sees Russia as being less vulnerable to external shocks and turbulence in energy markets than most oil-exporting nations due to its massive forex reserves as well as a flexible exchange rate.

Indeed, the lifting cost per barrel of oil equivalent for Russia’s largest oil producer, Rosneft, is now lower than the same metric for Saudi Arabia’s oil giant, Aramco – thanks mainly to a weaker ruble.

The ruble has weakened about 15 percent against the U.S. dollar over the past 30 days, recently hitting a four-year low against the greenback after the oil markets imploded. Russia, though, says it’s quite happy with oil prices in the range of $25 to $30 per barrel and can hold out at these levels for 6-10 years.

In fact, Russia’s Energy Minister Alexander Novak recently declared that Russian oil companies would remain competitive “at any forecast price level.”

One of the key factors working in Russia’s favor is a flexible exchange rate that allows its oil companies to collect revenues in dollars but pay their own expenses in rubles. A weakening ruble vs. the dollar can mean considerable margin expansion for Russian energy firms, as evidenced by Rosneft’s average lifting cost, which has fallen from $3.10 per barrel of oil equivalent last year to just $2.50 currently.

That’s even cheaper than Saudi Aramco’s figure, which has remained in the $2.50-2.80 range.

That’s the case because Saudi Arabia’s currency, the riyal, is pegged to the dollar at a fixed exchange rate. This means that the dollar costs for Saudi Aramco have remained roughly the same even after the oil price collapse.

By the same token, oil producers like Nigeria that defend a fixed exchange rate are likely to feel the heat more. The Nigerian government imposed currency controls to stem dollar outflows during the 2016 oil bust. Unfortunately, this has not stopped reports of a shortage of dollars in the giant African producer just weeks into the oil price war.

Can U.S. Shale Survive?

The U.S. shale oil and gas industry was facing an uncertain future long before the oil price war and consequent market crash thanks to burgeoning supplies, lackluster prices, increasing competition from renewable energy, and dwindling capital that pushed a record number of companies into bankruptcy.

As with the last oil bust, only the most robust, best-financed, and most efficient shale companies are likely to survive if prices remain depressed over a long period, once again reshaping an industry into one that is leaner and smaller. Pundits have already warned of a fresh wave of defaults and Chapter 11 bankruptcies this year, with oilfield services companies seen as being especially vulnerable. Dozens of shale companies have started idling rigs in the Permian while scores have announced dramatic cuts in shareholders programs, including share buybacks and dividends.

Despite the neverending turmoil, the U.S. shale sector is likely to survive the latest bust thanks to oil demand, which is expected to continue growing over the long term.

Consolidation and bankruptcy are actually good things for the bloated industry because it will help pool resources among the stronger remaining players, thus making for a more resilient sector in the coming years.

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  1. vlade

    Ok, let’s have a look:
    – oil at 20
    – likely to stay there for months
    – investors massively risk averse
    – no new money raisable easily

    Unless the US will bail them out, the shale is dead.

    1. divadab

      Yes but like any cyclical industry, operators go bankrupt, other operators buy up the equipment and leases from bankruptcy trustee, rinse and repeat. It’s the same in many cyclical industries.

      Shale not dead only lurking, having a nap. Take a longer view than most and you will understand better and maybe profit.

      1. vlade

        The new operators would have to have funding. Right now, they will not get any, anytime soon.

        If anything, majors can pick up the concessions on cheap and consolidate, if they have spare cash. It would help them to keep the prices of oil higher later too.

      2. Linden S.

        Yeah from the perspective of the fracking operations themselves this is just a lull..maybe companies involved will change but the whole operation will be waiting ready to come roaring back online.

        1. Wukchumni

          Silver linings are hard to come by these days, but my beloved Sierra Nevada which was destined to be decimated by fracking, will never happen. Hooray!

      3. PlutoniumKun

        Not necessarily. The geology is obviously still there, but if there is a major shut down its not so easy to start everything back up again, there is a lot of sunk cost involved. Skilled staff scatter, mothballed rigs deteriorate (assuming the Saudi’s don’t buy them up and scrap them), pipelines are cut. It would be very costly to start up drilling again, and in a world of dropping oil demand (which will certainly happen longer term), its doubtful if investors are going to be very interested in that exposure for years to come.

    2. periol

      The shale industry was already essentially a bail out.

      It would be beyond shocking if the bail out does not continue, more obviously this time. Terrible financial figures be damned.

      I don’t agree with it, but that’s America.

  2. PlutoniumKun

    One thing to throw into the mix is that oil is not an entirely fungible product – specific grades are tied to refinery capacity – this is why light shale oil (tight oil) must be mixed with heavier crudes from Canada and Venezuela in order to use existing refinery capacity (there was little interest in building light oil specific refineries, which should tell you something about how the industry viewed shale). So the casualties of lower prices aren’t necessarily the crudes with the highest marginal production cost. So much depends on who the refiners prefer to purchase from, and this is where it gets complicated (I suspect that those refineries owned by oil majors will try to only source from their own wells).

    Another issue is sunk costs – producers who want to cut capacity will be looking beyond immediate cost cutting in making their decision. For example, North Sea oil kept producing at a minimal level right through the low oil prices of the 1990’s despite huge losses – Statoil and BP and other big investors gambled that in the long term it was worth keeping those hugely expensive offshore rigs going in the hope of a long term recovery (which did of course pay off for them).

    All this boils down to my guess that the big boys of the oil industry will do what it can to save its big conventional oil investments (Gulf of Mexico, Alaska), and do their best to throttle shale and oil sands.

    Only one thing can possibly save shale oil now. Thats a major disruption to Middle East supplies, such as might happen in an all out war against Iran with forces based in Iraq. Don’t think that there are not people in Washington and elsewhere who are considering this.

    1. divadab

      what will save “shale” is time. The bankrupt operators will live on and bet your buttons they’ll be back.

    2. Susan the other

      Remember too, the royal family (Saud) bought a second home in Indonesia 3 or so years ago, so they’ve been planning for some crazy thing. They paid nearly a Tr $ for their own private island… when asked why they gave Indonesia so much money they said “Because we like them.”

    3. drumlin woodchuckles

      If the light Shale oil is used to dilute the Alberta Tar down to “heavy oil” levels, does that mean that a moratorium on light Shale oil availability will reduce Alberta Tar availability by “just that much” ? If it does, does that mean that there is a survivable time-span beyond which the un-payed-for costs of keeping the Alberta Tar mines ready for production resumption become so huge and unaffordable that Tar mining capacity can go extinct and stay that way?

      And if THAT is true ( oh PLEASE! oh PLEASE!), then if a big enough bunchload of leaner meaner greeners can strangle back their own post-corona oil use deep enough and long enough to keep Shale oil non-produced, can those leaner meaner greeners achieve the partial or total extermination of the Alberta Tar mine sector?

  3. Adam

    I’m a bit surprised that the price of oil falling so much would only hit Saudi Arabia’s GDP by less than 3% unless there was an increase in demand (which is the opposite of what would be expected at this point). World Bank has Saudi Arabia’s GDP at a little under 800 billion in 2018 (and a little under 700 billion in 2017). The OEC says that Saudi Arabia exported 125 billion in petroleum products in 2017 (not including petroleum by-products).

    Holding demand constant (which is generous at the moment), seems like oil prices being half the level they were in 2017 should have an impact of around 60 billion on GDP compared to 2017 (let alone compared to 2018 and 2019 when oil prices were higher). This is more like 9%. Anyone have any idea how the 3% number might come up?

    1. John k

      I thought the numbers looked low… bc I thought many oil exporters have almost no other exports. So a 50% cut in price is hugely disruptive… on less long term contracts or hedging in place. And all depending on oil revenues to maintain living standards. Lots of princes over there with big expenses…
      Russia clearly the exception.

  4. Amfortas the hippie

    one brother in law works at a frac sand place in Monahans, Texas…they’re endeavoring to keep everyone working, so far…he doesn’t know, but i assume it’s because sand is still in short supply for other things(IDK).
    other BIL works in pipelines(out of Midland)…he’s expecting to be laid off soon.
    Both work in the Permian…2 weeks on, 1 week off before current craziness…now, more irregular= longer time there.
    in other anecdotal news: cousin and i have been irregularly taking the truck down to look at the highway late at night(“late” generally means “with ample beer”). Few cars…mostly cargo type trucks, like the kind that deliver consumer goods; many, many more of those than before…which indicates to me that JIT is running full bore.
    and more at night for some reason. Highway(mile or more away from farm) is a lot louder than we’re used to…obviously truck traffic:Booming sounds….i lay here in bed, listening.
    daytime, more oil convoys heading south, towards I-10, and then east to Houston(per our last thursday trip): various pipe laden equipment and machinery, plus things like those big water carriers.
    buddy in oilfield trucking bidness says he’s pedal to metal hauling oil stuff back to houston…and he’s sucking up all he can in expectation that when it’s over, it’s over.
    gasoline…even way out here….is lower than i’ve seen it in 20 years or more…$1.80/gal as of sunday.

    1. divadab

      Fifty cent a gallon gas is coming. I caused all conversation to cease in my local hardware store by opining this. Petroleum is an industry with a more or less fixed refining capacity. Profits are maximised when running full tilt. SO the ideal from the refiner’s perspective is to have demand slightly higher than capacity. When demand drops below capacity, prices drop through the floor – because production capacity is more or less fixed.

      Many capital intensive industries are like this – gypsum wallboard, e.g. If this goes on for long, the weaker refiner(s) will go bankrupt. But someone else will buy their equipment and be ready for the next uptick in demand.

      Life goes on, as long as we don;t have a “bronze age collapse” event, with massive depopulations, loss of literacy and civilization in general, and reversion to a less advanced economy. This could happen but I doubt it. It would take much more – maybe a nuclear war, massive volcanic event (e.g. Yellowstone dome), etc. etc. You can;t plan for big events like that but you can plan for stuff like what’s happening now. That’s why this thing looks more and more like a created event to me. Some people will make out like bandits on the losses of others. Keep your cash handy, think like a vulture or a vampire, if you can do it. There will be opportunities.

  5. Off The Street

    Uber, Lyft and taxi drivers face challenging circumstances. Lower gas prices give them some slight benefit in operating expenses, but at what cost the risk of picking up a toxic fare?

  6. John

    I haven’t understood for awhile now what the plan for the US was.
    It seemed to be take the oil from the Middle East countries by force and by occupying them.
    That’s pretty much failed. And cost us trillions.

    The US has only 10 years left of proven reserves.
    List of countries by proven oil reserves

    What is the plan? Take Venezuela’s oil? That plan seems to have failed too. Though charging Maduro with drug trafficking means they are still trying I guess.

    1. periol

      I’m pretty sure that the US troops aren’t there securing oil for America.

      The contracts for Iraqi oil didn’t go to “American” companies, for the most part.

      Don’t forget the wikileaks drop where the State Department was threatening African nations on behalf of Shell.

      Very hard for me to see US actions in the Middle East as anything but the actions of an empire, making sure the spice flows to all proper allies. Beyond that the goal seems to be to create as much chaos as possible, so it’s very difficult for a functional state to rise from the ashes.

      1. John

        That’s what I said. We failed to get the oil contracts in Iraq.
        The Chinese got them.

        So what’s the plan to secure oil for the US when we only have 10 years left of domestic reserves and they are doing everything to keep us dependent on oil????

        1. drumlin woodchuckles

          Perhaps the plan for the super-rich individuals and families who own most of the “money” pumped by the oil industry . . . is to prepare to take all their money and then themselves to other safe-haven countries and let America fend for itself in the new post-petroleum era when the American oil runs out.

          Shrub Bush did buy a 200,000 acre estate over the world’s biggest fresh water aquifer in Paraguay some years ago, after all. Maybe that’s what all the oil mega-millionaires are quietly doing.

    2. John k

      The logical plan would be shift to renewables before we run out. But Exxon makes the plans, they want max price at least until our last barrel is pumped, which means renewables and fuel standards bad until,then.
      Current Russia saudi war, maybe with both targeting us frackers, must be pissing Exxon off, and clearly trump doesn’t have enough clout in Saudi to get them to stop. This might finally disrupt alliance with Saudi… well, I can hope.

      1. John

        Of course switching to renewals is the logical plan. But our policy is insanity at this point.

        That’s why I’m wondering, WHAT DO THEY HAVE UP THEIR SLEEVES?

        1. drumlin woodchuckles

          What they have up their sleeves may be to prepare to flee the country with all their money when the last profitable pumped-in-America barrel gets sold, and then let America fend for itself and let Darwin take the hindmost.

  7. David R Smith

    The plan is for Russia to nuke most of the Saudi oilfields. Leave them radioactive for at least a decade. The US will stand down at the behest of domestic oil and gas interests. MBS will be publicly beheaded.

    1. The Rev Kev

      You’re right! America should nuke those Saudi oilfields first shouting “Remember 9/11!” before the Russkies have a chance to do it first. That’ll teach them.

      1. drumlin woodchuckles

        I would not recommend that. But an intriguing variant occurred to me. Why not occupy the oil fields just long enough to deep-inject high-level nuclear waste down into the oil itself? That way, as long as no one ever pumps any more of the oil, the high level nuclear waste will stay safely underground away from us.

        And if anyone pumps any of the high level radioactivated oil, they and everyone involved will get lethal doses of radiation.

  8. Susan the other

    Let us all hope sanity prevails. This post gives a new dimension to Richard Murphy’s idea that we need a new bankruptcy vehicle – an oil bankruptcy process for manufacturing and retail businesses that can not afford to stay open due to the cost of oil. Now we have (maybe he saw this coming) producers that can no longer stay open because the price of oil is too low to cover their costs. Just like Gail Tvergerg predicted – if it is too costly for manufacturers they won’t buy; if it is too costly to produce they won’t pump. That’s when government must step in. imo we will keep shale on life support, as we have been doing, allow it to consolidate, maintain the wells. But this looks like bankruptcy in all directions and we haven’t even considered just how much oil energy allows us to run the world on the cheap. With that one massive source of cheap energy being cut on the supply side and the demand side at the same time it’s hard to imagine anything for years to come that doesn’t involve rationing and government subsidy. Years.

    1. Synoia

      1. Abandon a single price for oil worldwide.
      2. Ban imports of oil, or impose tariffs.

      Protect you local industry. Protect your local jobs and economy.

      Repeat for all categories of goods.

      1. Susan the other

        Maintain oil supply to gradually phase it out. We can go forward producing solar, wind, thermal, etc only as fast as we can produce the energy to manufacture the panels and propellers, etc. So the irony is that we need oil to get rid of oil. It will take some time – we need to maintain the flow of oil very carefully to accomplish what we need to do. Non-essential goods will be hit harder than agriculture and essentials like medical services. Rock and a hard place because our economy is 80% consumerism. That includes tons of non-essential commerce; the restrictions on non-essentials will create further economic disruptions, unemployment; and blablablah.

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