The Oil Industry in a Turmoil
From 70$ on january 6 to 27$ today, the oil price has been plummeting to a historical low record in response to a global freefall demand due to the combination of coronavirus outbreak and the price war between Russia and Saudi Arabia. The fear is now to see US shale oil companies significantly impacted.
The coronavirus impact on oil price
The Brent crude oil price downward trend started once the coronavirus outbreak was declared in Wuhan in december 2019. At that time, the virus hadn’t crossed the chinese borders yet but the consumption had started to curtail following travel restrictions and quarantines measures imposed in China. However, fears of seeing a further decrease of the fuel demand increased when we realized the virus was spreading all across the world and that western governments could also quickly impose lockdowns in cities or countries and restrictions on air and road travel - what has eventually been done -. Analysts finally claim that the oil consumption could be 2 percents lower than expected this year.
Saudi Arabia-Russia price war
Initially, Saudi Arabia whished to prompt OPEC and Russia to cut oil production to counter the slumping demand following the slowing economic activity due to the virus outbreak. Consequently , this sanitary crisis urged the OPEC members and other oil producers to meet at an emergency summit that took place on 5 March in Vienna. Soon after the summit, Russia’s energy minister objected the Saudi’s and OPEC proposal by allowing their producers to produce as much as they want claiming they first wanted to know the actual and long-term impact of the pandemic on oil demand. But the drop in demand would rather be an opportunity for Moscow to strike the US shale industry. Afterward, the kingdom who saw the Russian decision as a provocation, then responded by raising productions. Indeed, Saudi Aramco -the Saudi’s national oil company- proposed to discount its crude oil price to 8$/barrel intending to flood the market. In addition, the kingdom ordered the company to raise its daily ouput by almost 26%. It is relevant to know that Saudis are in a strong position in this price war because they know they are the only one able to withstand a long-term barrel price of 25$ - up to 10 years.
"US oil production could drop from [...] 13m b/d today to 2.5m b/d by the end of 2021"
Why is US shale sector so vulnerable ?
The US shale sector is most at risk to this crisis. The collapsing demand resulting to the coronavirus pandemic and the increase of supply generated by Russia and Saudi are both a dreaded threat. Shale is indeed very expensive to extract and is vulnerable to low prices. Exxon’s is the best exemple. It has seen its market capitalisation falling to 161.5B. According to most of Analysts, US oil production could drop from its highest record of 13m b/d today to 2.5m b/d by the end of 2021. The Chevron’s decision to cut its capex in shale by 2bn$ this year has been followed by many others of the sector that could lead to a drop of almost half the current capex. This will significantly impact the current US’s independence on foreign oil supplies weakening its international negociating clout. The major impact of this crisis lies in the shale oil outputs costs. The companies cannot afford to see their selling price going downward. As quoted in the Financial Times : «Shale thrives at $100 a barrel, survives at $50 and dies at $25 ».
As a result, rating agencies have since downgraded the creditworthiness of many of the sector’s companies which constantly need cash injection to keep their production steady. Their remainng hopes are now dwelling in the in a oil price recovery which mainly depend on how aggressively Saudi Arabia will keep increasing its supply.
As a large number of US shale producers are facing bankruptcy, Donald Trump is starting to put pressure on Saudi Arabia to end the price war allowing to mitigate the turmoil the energy market is currently into. However, it is still unclear whether Saudis would change their stance even though they are aware that at long-term, Russia is not able to keep a production at a high pace with such low prices.It is also important to remember that the decision taken by Saudi Arabia was made before it has become clear how badly the outbreak could hit the global demand. However, thanks to their low cost production plants, Riyadh could see here an opportunity to easily gain market shares. Uncertainty remains…
Édouard Wauquier - Head of Corporate Finance