A perfect storm is forming over the United States shale oil patch.
Following the collapse of the alliance between Saudi Arabia-led OPEC and its most important ally – Russia – on Friday, the kingdom threw down the gauntlet. The Saudis slashed the prices they charge for crude, and reportedly are preparing to open up the oil taps even more next month, saturating a market already reeling from waning demand in the face of coronavirus disruptions.
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At $2.8 per barrel, Saudi state oil giant Aramco has the lowest production costs in the world. US shale oil producers need crude to fetch a price that is more than 14 times higher to cover their costs. Now, the oil price war that has erupted has US shale oil companies rushing to cut spending and rein in their production.
Global benchmark Brent crude fell 30 percent on Monday, the largest one-day slide since the 1991 Gulf War, before pairing some of those losses. US benchmark West Texas Intermediate crude tanked 24.59 percent to settle at $31.13 per barrel.
For the last three years, OPEC and its allies, chiefly Russia, have cut supply to support prices, leaving the door open for US shale producers to boost production and capture market share.
The US is now the largest oil producer in the world, pumping out nearly 13 million barrels per day (bpd), but the companies operating fields in Texas, New Mexico and other states have struggled to make enough money to satisfy investors.
Recently, oil output more than doubled in New Mexico, generating more than $500m in proceeds from past auctions, and lifting it to become the third-largest US producing state. Colorado rose to the fifth-largest by volume last year.
Even before the alliance between OPEC and Russia collapsed, those companies were already pulling back on capital expenditures, and that activity will accelerate.
Shale companies need prices at least in the low $40s per barrel to cover direct costs, said Ian Nieboer, a managing director at consultant Enverus. If US prices remain at a low-$30-a-barrel range, “it starts to look more lethal,” he said.
Diamondback Energy Inc and Parsley Energy Inc – two of the largest shale independents – said they slashed drilling and well completions to maintain cash flow above ongoing expenses.
The cuts reflect a wave of reductions under way elsewhere, said analysts.
Producer shares dropped sharply on Monday. Larger oil companies with refining and chemicals businesses also got pummelled, but not as badly.
Diamondback said that it released a third of the crews completing new wells, that it plans to cut three drilling rigs this quarter, and that it will reduce its 2020 spending budget by an undisclosed amount.
The lower activity will remain “until we see clear signs of commodity price recovery,” said Diamondback Chief Executive Travis Stice. “We will maintain positive cash flow and protect our balance sheet and dividend.”
The US government recently forecast domestic production would rise one million barrels per day (bpd) to more than 13 million bpd. But in light of reduced demand and OPEC’s higher output, oil production growth “will be roughly zero” compared with 2019, estimated Paul Mecray, managing director for Tower Bridge Advisors.
Reduced global demand means the call on US shale will fall 2-3 million bpd, said Paul Sankey, a researcher at investment firm Mizuho Americas. That would imply an additional 20 percent reduction in oil companies’ spending this year, he wrote.
The weekend decision by OPEC to pump full bore is analogous to what the cartel did around 2014, said Brock Hudson, managing director at investment bankers Carl Marks Advisors. That effort – designed to keep OPEC’s market share against a rising US shale output – ultimately failed, and OPEC later set production curbs.
But this time, shale is lacking support from investors who four years ago bought their debt, financed reorganisations and kept shale producing.
US producers are “going to be suspending completions and things like that to keep producing”, said Hudson.
Companies likely will halt well completions at a pace that could lead US production to decline by one million bpd by the end of summer, said Richard Spears, vice president of oilfield consultancy Spears & Associates.
The ripple effect will hit oilfield service firms and state budgets. Scandrill Inc expects to cut about 22 workers assigned to one rig after a customer on Friday decided to pull back on new drilling, said Senior Vice President Paul Mosvold.
“Private equity-backed [oil companies] are going to pull back fairly dramatically on the rig count, which is the canary in the coal mine,” Mosvold said.