How Will Alberta Oil Weather the Price War Storm Caused by COVID-19?
Will the break between OPEC and Russia cause a collapse in Shale? And how will Alberta fair during this dramatic price war?
As we have witnessed this week with the coronavirus spreading around the world, stock prices have been in free fall and oil prices are plummeting. It is suggested that if the coronavirus continues beyond April with prolonged economic disruption it could cause a full-fledged recession. How will our already struggling Alberta Oil companies survive another price war?
This price war really started in 2014 because of Shale Energy
In 2014, the US boomed onto the scene with its revolution in shale energy, capturing a greater and greater slice of the global oil market. In just six years, US shale oil production grew to over 4 million barrels a day from around 0.4 million barrels a day. The stunning rise completely upended the years-long dynamic in which the US was mostly an energy importer, not exporter. Instead of paying Saudi Arabia and Russia for their oil, America was now a serious competitor. Naturally, the Saudis and Russians, the world’s two largest oil exporters at the time, weren’t pleased.
In 2016, Saudi Arabia and Russia agreed to cooperate in the world oil market by coordinating their production in a pact known as OPEC+. They felt that together they could swing global oil prices. At the time, despite being asked by the Saudis, Russia didn’t really cut its production — leaving Saudi Arabia to shoulder the burden of trying to drive out US Shale producers. Russia has long argued that production cuts are merely playing into the hands of US shale because the more production OPEC+ members cut, the more US shale ramped up its production.
The US shale industry persisted and continued to gain strength, as OPEC+ cut its oil output by 4 to 5 million barrels per day. That didn’t really lead to a hike in price, though, because the US shale industry kept producing and exporting oil. Between America’s growing exports and Saudi Arabia’s overproduction, there was a glut of oil for sale and the price continued to plummet. Saudi Arabia and Russia survived the earlier price war by selling cheaper oil to China. Which made Russia and OPEC+ even more reliant on their new Chinese customer.
The US eventually surpassed both Saudi Arabia and Russia as the world’s leading crude producer in 2018.
Is it really about COVID-19 or taking the opportunity to bring down US Shale?
Last week, members of the OPEC+, a cartel of 15 countries of oil-producing nations, met at OPEC’s headquarters in Vienna to discuss what to do as the disease’s impact has temporarily lowered global demand for oil. Saudi Arabia, suggested collectively cut their oil production by about 1 million barrels per day, with Russia making the most dramatic cut of around 500,000 barrels a day. In doing so, it would keep oil prices higher. Russia opted against the plan.
Saudi Arabia didn’t take too kindly to the Russia’s decision to decline and responded by slashing its export prices to China in a bid to retake market share and put pressure on Russia. Those actions brought the biggest per barrel one-day drop since 1991 – bringing down prices by about $11 to $35 a barrel.
Some are suggesting the COVID-19 has given Russia an opportunity to split from its deal with OPEC because they want prices lowered — not propped up via its Saudi deal — to hurt the American shale industry and thereby regain global market share.
However, the price war brought on by Russia and Saudi Arabia may be for not, as the Shale Revolution as it’s called, has big internal problems of its own. Analysts have been predicting that many US oil companies were already facing tough times before this latest price war. US shale has long been accused of being over leveraged and debt-laden. Until now they’ve been able to rely on deep-pocketed investors who were willing to pour fresh capital into the industry, despite years of lackluster returns. David Deckelbaum, an analyst at investment bank Cowen said. “This is an industry that for every dollar they have brought in, they have spent two,”
Previous to the latest crisis, providers of capital that made the shale explosion possible had started demanding better returns. Over the last few years, U.S. oil producers witnessed a sharp rise in their debt-to-equity ratios, thereby causing a sharp surge in the number of bankruptcies in 2019. The previous year saw a staggering 50% of them go belly up.
Where does that leave Alberta in this COVID-19 lead price war?
While Saudi Arabia and Russia take on the US Shale market, there is some optimism among Alberta oil companies that the short-term price plunge could clear out competition in the United States shale oil sector, creating longer-term opportunities for Alberta producers to regain market share.
“For now, the impact on oil production in Alberta’s oil patch looks likely to be more contained than in the U.S. shale-oil fields because Alberta’s energy industry has lowered costs and become much more efficient over the years. Oil companies are leaner than they used to be, investment levels are lower and employment per barrel is lower.” said Rene Santos, manager of North America supply analytics at S&P Global Platt
Over the past five years, innovative companies have already learned to endure some of the lowest prices in the world. “Western Canada is accustomed to incredible price volatility, the likes of which the world doesn’t get to enjoy typically” said Kevin Birn, IHS MarkIt. “Oil Sands producers have significantly driven down costs from their operations and in doing so, they’re more capable of weathering the storm. But it doesn’t mean it’s going to be fun.”
While the lower oil prices could make a number of new U.S. shale-oil developments uneconomical, the impact on Alberta’s producers will be more limited because our industry is battle-hardened. Analysts are predicting that if sustained oil price stay under $40 per barrel it will have a devastating effect on the Shale industry because they need prices in the low $40s to cover direct costs. Western Canadian companies on the other hand, are in a better position because producers break even if the price of a West Texas barrel is somewhere in the high-US$30 range.
Undefended oil producers — anywhere in the world — are those that haven’t taken precautions and continue to have high costs, too much debt and no access to capital. Alberta producers can do well to continue doing what their doing – keep being innovative, fighting for the right to export its product to the world and staying competitive while riding out the storm that is brewing elsewhere in the world.
““Life offers few guarantees, but generally the harder and longer you work, the more likely you will succeed. Mike Bailey – President, AiM ”