Thursday Thought: Understanding the Current Oil Crisis

Since our programs in April have been postponed to the Fall, we are bringing you Tower Center Thursday Thought. Every other Thursday, we will post a Q&A with one of our Fellows on this unprecedented time.

This week, we interviewed SMU Tower Center Diplomat-in-Residence, Former Ambassador Robert Jordan to gain a better understanding on the current oil crisis.

How has the pandemic affected the oil market?

The pandemic has had a catastrophic effect on the oil market. Demand was already soft, but it has now been devastated. Commentators expect demand to be down 20% or more this year, which would equate to nearly 20 million barrels a day.

Can you comment on the price war between Saudi Arabia and Russia?  Why are they doing this, especially at a time of global economic crisis?

The Saudis and Russians had an agreement to limit production to keep prices up. But when time for renewal came, Russia refused to continue and announced plans for production increases. Why? With demand down, Russia needed more volume, and the previous production limitation agreement did not keep prices high enough. Moreover, it was an opportunity for Russia to punish U.S. shale producers, which had added significant production to the market and further depressing prices. Russia has also been alarmed at U.S. sanctions on their support for Venezuela, Iran and the Nord Stream 2 Gas Project in Europe. The Saudis decided to follow suit to protect their market share. If they kept supply limited, Russia could move into their markets. The Saudis may have calculated that Russia would relent at some point, and most likely did not mind wiping out some marginal U.S. shale producers.

What does all this mean for the U.S. domestic oil and gas industry, especially here in Texas?

The price war was a serious threat to the U.S. oil and gas industry, especially in Texas. Both OPEC + Russia met on April 9 and agreed to take approximately 10 million barrels a day off the market for two months, which will support a modest price increase. After that period the volume of production cuts will be reduced over a period of months. The agreement made April 11 with most remaining producers will still not reduce supply sufficiently to balance the market, and the collapse in demand will keep prices below the break-even point for many producers.

Will the shale/fracking industry survive?

American technology and ingenuity brought the industry through tough times in the past and many will survive. However, a number of independent companies have high leverage with debt payments of nearly $86 billion coming due in the next two years. Some of them will not survive and may take down lenders, service companies, and suppliers with them.

Can you look into your crystal ball and tell us when things might return to ‘normal’ and what that will look like?

We may be looking at a new normal. There is a question whether demand will rebound to previous highs, and short-term supply will continue to be robust. The U.S. shale industry will disinvest in the short term, which means that when demand rises there will be a potential rebalancing and prices could increase due to wells having been shut down or production deferred. There will be consolidation in the industry, with the majors and well financed independents buying up smaller troubled producers or their assets. A lot of the timing depends on how long the pandemic persists and when the world’s economy ramps up. It will likely be a year or more before a “new normal” emerges.