American Shale Is Now Under Attack

While there is anecdotal information circulating that Russia and Saudi Arabia are considering a renewal of talks on production cuts, there is also no indication that that this will be taking place anytime soon.

Prevailing opinion among my folks looks at no formal meeting is likely until the next scheduled OPEC+ session in June, although there may be some under-the-radar sessions before that.

If those happen, they’ll take place against an uncertain backdrop…

Russia and Saudi Arabia Are Putting on a Brave Face, But…

There is bravado coming out of Moscow, where officials are claiming the country can withstand $25 a barrel crude for years. That is, of course, patently absurd. The central budget is barely able to handle oil in the mid-$40 range and then only with a Russian version of unfunded mandates – where a government decrees services or expenditures but does not actually provide designated venues to pay for them.

The argument says that reserves can cover the shortfall, essentially drawing money from the national sovereign wealth funds (SWFs) set up to collect revenues from oil and natural gas exports. U.S. sanctions restricting Russian access to international financial markets and the substantial cost of projects run “off the books” distort the value of the reserves. And then there is the increasing need to support the ruble against other currencies in the forex market and the expanding precarious trade on domestic treasury paper.

The SWF path, therefore, is less of a solution than Moscow has portrayed.

Over the past 48 hours, Saudi Aramco has extended even further dramatic cuts in export prices to Europe, further stating it would increase production to effective capacity (approaching 13 million barrels a day) and direct the additional volume to restricting Russian sales in both Europe and Asia (where the demand curve internationally has been moving for some time).

The Kremlin has no real response other than to accelerate a draining of reserves in defense of an increasingly vulnerable oil industry. That Russia’s primary throughput to Europe, which remains its main export market, is via the Druzhba (“Friendship”) pipeline. Unfortunately, the pipeline still recovering from major impurity problems that prompted a complete cut in transit after massive corrosion took place at end user facilities.

Unless it can prompt somebody else to shoulder the revenue cuts.

What had been mentioned privately by sources in Minenergo (The Russian Energy Ministry), is filtering out publicly. The target has become to pressure a decline in U.S. exports.

Both Saudi and Russian leadership regarded restricting American shale oil access to global markets a main goal in the 2015 oil pricing collapse, also a move to defend market share rather than price.

Domestically, a rising number of US produces are again facing tough times. The dramatic decline in prices during the 2015-early 2016 period resulted in substantial cuts in forward field capital expenditure commitments. Anything beyond half cycle drilling (comprising extensions, or “step out,” wells from existing production) were cost prohibitive. That guaranteed an expensive adjustment when new lifting became necessary to compensate for declining extractions from existing wells.

That quandary is now here.

Unfortunately, so are increasing debt costs. As I have noted in several previous Oil & Energy Investor installments, most U.S. producers, especially smaller ones in the prolific Permian Basin of West Texas and Eastern New Mexico, run cash-poor. They finance new operations not from existing sales revenues but from high-yield (“junk”) bonds. The current mess in the bond markets has made availability and affordability suspect.

This will lead to another wave of mergers and acquisitions, insolvencies, and a contraction in those working the American oil patch.

Prices remaining in the low $30 range for any length of time will result in reduced U.S. exports. Yes, foreign markets provide higher prices, but in the current global demand climate that will not provide sufficient margin for many companies looking at export sales as a remedy for declining revenues.

Both Moscow and Riyadh believe the one joint positive from this oil war is a genuine opportunity to oblige U.S. exporters to “cry ‘Uncle!’”

Known Unknowns and (Mostly) Unknown Unknowns

Meanwhile, back in the U.S. ongoing angst over COVID-19 (coronavirus) and its impact on economic activity remains the great unknown. Aside from the overall pressures on the stock market, Americans are facing a pronounced change in lifestyle as social connections undergo substantial changes.

All gatherings of more than a few people are becoming a thing of the past. Broadway is essentially closed, nobody is shopping, and fundamental revisions are taking place in how candidates are campaigning (this is, after all, still an election year).

No sporting events to distract our attention from what is happening. Even games that may sneak through are going to be without an audience. NBA, NHL, and MLS games NCAA “March Madness” championships, and the Major League Baseball season are all either cancelled or an indefinite hold. Will there still be an NFL draft? Unknown…

As one barometer of the economic consequences in these times of uncertainty of the times, consider this. What is ESPN to do with all its now dead airtime? And as an advertiser, why would I have an interest in running commercials on it if there is no reason for people to watch?

Sincerely,


Kent

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