COVID-19 has changed almost every way the world works. Governments are paying people to stay at home. Landlords are telling tenants to use rent money to settle other bills first. And Texas is telling oil titan Saudi Arabia: “Never mind if you aren't cutting your production, we’ll cut for you.”
After 40 years of demanding that the Saudis and the Organization of the Petroleum Exporting Countries keep their spigots fully open at all times and pump as much crude as possible, the United States is begging Riyadh and OPEC to do the opposite. If not, it’s willing to shut its own oilfields.
Leading the American initiative on this is none other than Texas, the U.S. state with the largest amount of hydrocarbons output and reserves.
Pioneer Natural Resources (NYSE:PXD) and Parsley Energy (NYSE:PE) — two of Texas’ leading crude producers — are asking regulators in the Lone Star State for an emergency meeting to consider curbs on output as a cratering oil market threatens to bury much of the industry.
A five-page letter, signed by the chief executives of both companies and shared with Bloomberg News, said the firms sought a virtual meeting no later than April 13 with the three-member Texas Railroad Commission. Ryan Sitton, one of TRC’s commissioners, said on Monday the regulating body would discuss oil output curbs at its next meeting.
TRC and Sitton have been in the news lately since the Wall Street Journal first reported that Texas was planning to set oil quotas for its producers. If so, it would be the state's first curb on its drillers since the 1970s, when overproduction by Texas then set off the infamous Arab oil embargo.
A Journal story from March 19 said several oil industry executives in Texas had approached the TRC to intervene in the current market. Texas, after all, was the original inspiration for OPEC’s model of influencing global oil prices through production controls.
Catalyst For Curbs?
But even before the Journal report, there had been a stir since February over a Bloomberg story about a natural gas flaring report prepared by Sitton that could become a catalyst for the commission to place curbs on the industry.
Gas is a byproduct of crude production and its flaring has become one of the worst side effects of the shale boom in Texas.
As Bloomberg noted in its own February interview with Sitton, vast amounts of gas from oil wells in the Permian Basin were being burnt off for lack of pipelines to ship it away. While pressure mounts to curb the practice, a supply glut, depressed U.S. gas prices and the distance from key markets for the heating fuel means the byproduct of crude production has little value for explorers in the state.
Sitton went a step further on March 20, holding a phone conservation with OPEC Secretary-General Mohammed Barkindo and tweeting jubilantly afterward that he had been invited to the cartel’s next meeting in June. “We all agree an international deal must get done to ensure economic stability as we recover from COVID-19,” he added.
Three Strikes
All that was in the background. Now, the present: the original request for TRC intervention was the first strike in Texas’ plans to cut. Sitton’s call to Barkindo was the second. The joint letter by Pioneer and Parsley to the TRC and the upcoming meeting of the regulating body to formally discuss the matter will be the third.
Yet, there are doubts on whether Texas is up to the task of becoming the next OPEC.
The same afternoon that Sitton excitedly tweeted about his call with Barkindo and going to Vienna in June — COVID-permitting — for the cartel’s meeting, TRC Chairman Wayne Christian poured cold water on plans for the commission to play police for oil quotas. He said in a statement:
“While I am open to any and all ideas to protect the Texas Miracle, as a free-market conservative I have a number of reservations about this approach."
“First, Texas does not operate in a vacuum,” he said. “If we prorate our oil, there is no guarantee other nations, or even states will follow suit. From a practical standpoint, the Railroad Commission has not prorated oil in over forty years; we do not have staff at the agency with experience in this process and our IT capabilities to handle this process are limited at best."
Just like Christian, not all share the enthusiasm that Pioneer, Parsley and Sitton have for cuts. Industry group American Petroleum Institute has criticized the plan while Mike Wirth, CEO of oil major Chevron (NYSE:CVX), has flatly refused to cooperate: “U.S. companies cannot coordinate on oil output cuts,” Wirth said.
But what choice do U.S. producers have? With West Texas Intermediate crude hitting an 18-year low of $19.27 on Monday, the demand destruction from COVID-19 and the production-and-price-war between Saudi Arabia and Russia are combining into a perfect storm for U.S. oil producers.
Goldman Sachs estimates that crude demand for this week itself will be 26 million barrels per day, or 25%, below norm.
From NOPEC to “Yes, OPEC!”
Just over a year ago, the U.S. Congress was toying with two bills that would have made any sort of production fixing in oil — including the one being planned now by Pioneer, Parsley and Sitton — illegal.
The No Oil Producing and Exporting Cartels Act (NOPEC) was drafted for suing OPEC for its activities, while the Defending American Security From Kremlin Aggression Act (DASKA) was meant to deter the Russians from similar action. Both bills were drafted at the height of the 2018 market gyrations when President Donald Trump was eager to keep U.S. pump prices down ahead of midterm elections that November.
But now, analysts say, if WTI doesn’t get to $40 by the year-end — and many don’t think it will — some 30% or more of U.S. drillers could go belly up, regardless of cuts in capital expenditure, exploration or outright production.
The only redemption for drillers from Texas to North Dakota might come from a retreat in Saudi production. As of now, the Kingdom seems set on growing its output by a whopping 30% over the coming weeks to reach a record 12.3 million barrels per day by end-April. It has also rejected overtures by the Trump administration to try and change its mind.
In fact, anyone who understands the Saudi-Russian tussle for market share will know that both are out to decimate U.S. drillers, who gained 4 million barrels per day in crude volumes over the past three years to become the No. 1 world producer cranking out 13 million barrels per day.
In that same time, Riyadh was diligently enforcing cuts to its production under the OPEC+ initiative while the Kremlin largely played hooky with the Saudis under that pact. Now the gloves have come off, and nothing metaphorically short of a boxing victory — with U.S. drillers on the mat and the Saudis standing, gloating, over them with arms outstretched — might do.
All Are Hurting
This doesn’t mean that the Saudis and Russians aren’t hurting from the apocalyptic moment in oil now, and their actions that have contributed to it. Riyadh, which needs oil at $80 for its budget, is looking to slash capital expenditure at state-owned oil giant Saudi Aramco (SE:2222) by as much as 25% from 2019’s $32.8 billion.
Moscow’s own oil giant Rosneft (MCX:ROSN) is, meanwhile, selling some assets at home to shore up its finances. Russia is also expected to suffer from a collapse in demand for its Urals, a heavy crude composition of oil produced in Ural, Western Siberia and Povolzhye that is more costly to produce gasoline from than from the lighter Brent.
Such pain could, ultimately, force the two giants to yield to common sense and go back to cutting some production at least.
“There will be no clear winners. For now, it’s everyone on its own, and supply reductions will happen through prices," said Olivier Jakob of Swiss oil risk consultancy Petromatrix.
Energy Intelligence, a New York-based consultancy, agrees, saying “oil fundamentals, destabilized financial markets and the prospect of a deep recession are pushing participants toward an inevitable return to market management.”
So, an OPEC 2.0 in Houston? That will be interesting.