Few industries have been more brutally pummeled by the coronavirus pandemic than the oil business. Huge declines in demand have threatened the survival of many oil companies and is even threatening to destabilize oil-dependent foreign governments. The resulting price shock sent the price of oil below $30 per barrel.
An extensive report published by Knowledge@Wharton notes the negative price shock occurred in the wake of anxiety that had gripped traders and investors over reports that storage capacity was running perilously short at Cushing, Okla., the sole delivery point for West Texas Intermediate crude. The impulse was a rush to sell. The panic over the shortage of storage capacity led to a rush to dump futures contracts, observes Charles Mason, University of Wyoming professor of petroleum and natural gas economics.
The April 20 price crash “emphasized how much oversupply there is at the current time,” says Wharton finance professor Jeremy Siegel. “It was a terrible misestimate by traders of the storage capabilities in Cushing, Oklahoma,” he added. “Otherwise why would people be buying long contracts?”
Oil producers have been responding to the uncertainty over demand with a wait-and-watch approach, according to Knowledge@Wharton, and holding off on fresh investments.
The current prices are far from levels where producers could recoup their costs to produce. Drilling new wells in the current scenario is unlikely because of the high upfront costs they entail, says Mason. But drilled and uncompleted wells could be converted into producing wells at a “low incremental cost.”
That means it’s inevitable consolidation is coming to the oil industry. Weaker companies will be acquired or closed down, and consolidation is imminent also in the oilfield services industry, Mason adds.
U.S. oil prices have continued to decline because of fears over storage capacity, and many analysts worry that prices could fall below $10 a barrel. “If prices settle at $10 for an extended period, it will mean the industry is in deep trouble,” Craig Pirrong, University of Houston professor of finance with an expertise in commodity markets, told Knowledge@Wharton.
“A ‘new normal’ of sub-$10 oil prices would surely kill new investment and exploration activities, and would even force existing producers to shut down,” says Arthur van Benthem, Wharton professor business economics and public policy. “This is already happening.”
The situation has major geopolitical implications too. OPEC, which once held dominion of the global oil market, has seen its power wane in recent decades, as its member fail to honor the production agreements they enact.
The stark reality facing yesteryear’s oil producers is that “there are just too many opportunities to find oil elsewhere,” says Mason, pointing in particular to the tight oil deposits in the Permian Basin. Production in the United States has been on a steady climb since 2008 when the first shale oil well was drilled into the Eagle Ford Shale in Texas. The growing U.S. influence in global oil markets ends up negating attempts by other oil producing countries to prop up prices.
Read the complete Knowledge@Wharton report at this link: https://whr.tn/2Wbewba
Mike Consol (m.consol@irei.com) is editor of Real Assets Adviser. Follow him on Twitter @mikeconsol to read his latest postings.