By Ryan Sitton
But make no mistake: These prices are not market-driven. For the first time, supply and demand are simultaneously being warped by forces completely outside of normal economic conditions. Fears of coronavirus have decimated our short-term transportation demand; global estimates range from a drop of 5 million to 10 million barrels a day. Meanwhile, Saudi Arabia is using its spare capacity to challenge Russia for market share and force compliance with production cuts. In doing so, Saudi Arabia says it will place an additional 3 million barrels a day of oil on the market, artificially cutting prices. It appears that the global oil market could be oversupplied by 10 million to 15 million barrels per day, or roughly 10% to 15%, making it the highest level of oversupply since 1974 — during the Arab oil embargo.
The last 10 years have brought the latest wave of oversupply, as the world’s demand for energy from oil and gas continues to climb. A surplus of oil as high as 1.5 billion barrels could be hitting the market in the coming months. This would far exceed available storage, which may drive oil prices to their lowest ever and force companies to shut down production and cut off necessary cash flow to remain in operation.
The shale revolution made the U.S. the world’s largest oil producer and net exporter, producing in excess of 13 million barrels of oil per day. At current forecasts, this level of production may drop to 5 million to 6 million barrels of oil per day over the next few years, threatening American energy independence and returning the U.S. to the days when wars in the Middle East wreaked havoc on our economy.
Texas is the world’s third-largest oil producer. The oil price war endangers the state’s economy and, with it, the national economy. Tens of thousands of Texans are being laid off in West Texas in the Permian Basin and the Eagle Ford shale of South Texas as companies shut down their drilling rigs. The U.S. and Texas stand at a disadvantage in one respect: Both the Saudi and Russian governments control their oil production, while the U.S. operates a free and open market.
Free markets have made the U.S. the world’s strongest and most prosperous nation. But we face serious threats. In the short run, we are at risk that a key part of our economy — our energy sector — will enter a dramatic downturn. In the long run, there are even higher risks that energy supply will be disrupted when demand returns. If U.S. oil production drops by 3 million to 4 million barrels per day as a result of artificially low prices, then, in a year or two, when demand comes back and the Saudis and Russians are playing nice, things may look very different. We could see $100-per-barrel oil, and $4-per-gallon gasoline, with a large chunk of that money going overseas. That will cause substantial economic pain to everyone in America.
The good news is, we know demand will come back. Demand for oil and gas has grown every single year for the last century. The challenge is weathering this temporary storm.
What can we do?
First, for those of us in the oil and gas industry, this is an opportunity to evolve. How can we find opportunities to cut costs and improve productivity? When demand does come back, how can we be ready to move fast to fill it? How can we use data to reduce risk and predict system performance so that our overall risk profile goes down? Slowdowns create the opportunity for us to develop new tools and solutions to capitalize on future opportunities. That is how we have always been successful.
Second, this is an opportunity for the U.S., especially Texas, to lead in a way we haven’t in a generation. No one — not the Saudis, Russians, Americans or anyone else — benefits from unstable energy supplies. Economies thrive when energy is predictable and affordable. The world needs Saudi Arabia and Russia to stop flooding the market. Now is the time for our leaders to stave off an extended oil war. And, unbeknownst to most, we have something specific to bring to the table.
The Texas Railroad Commission, which regulates oil and gas production in the state, has the authority to set pro-rationing schedules, thereby limiting production for Texas producers. That power has not been used since 1973. In theory, Texas could cut production by 10%, and if Saudi Arabia is willing to cut production by 10% from its pre-pandemic levels and Russia is willing to do the same, it would return the market to pre-crisis levels (and only somewhat oversupplied). While Texas controls its destiny, it doesn’t control that of others. We would need our federal government, and our president, to make a deal that stabilizes oil markets.
With other governments manipulating oil markets, it’s fair to ask: Why shouldn’t our government step in to try to reinstate a more market-based approach? In an ideal world, this wouldn’t send prices up even to the prices seen three weeks ago. Instead, it would stabilize oil prices in the mid-$30s or so. It would still mean hard times for oil companies and low gasoline prices for consumers, but it would stave off a total oil industry meltdown.
We don’t have the whole picture yet, but with a global pandemic disrupting our lives, perhaps it is worth discussing whether pro-rationing for Texas producers is appropriate, if it can return the world back to the market.
We are facing some of the most uncertain times in decades, perhaps generations. We will face them together. Perhaps it is time for the world leader in energy markets to once again be the United States.