What, And Where, To Shut?

Consensus estimates indicate that the full extent of the Covid-19 pandemic will wipe out at least 18.5 mmb/d of oil demand in 2020 alone. Some analysts have gone even further, suggesting that the number could go as high as 30 mmb/d. As supply reacts to demand, there is no doubt that producers must throttle back production to avoid a destructive oversupply that has already decimated crude oil prices. OPEC+’s new two-year supply deal promises to take 9.7 mmb/d off the market through June 2020, then declining gently. At its best, this will only account for half of the demand shortfall, leaving an excess of at least another 9 mmb/d. In the extraordinary OPEC+ and G20 meetings that surrounded the coordinated deal, it was stated that the free market producers – mainly the US, Canada, Brazil and Norway – would make up a further cut of 5 mmb/d through natural ‘market adjustments’. The question, then, is how?

For the OPEC nations, this is relatively easy. Most are oligarchies, controlled environments where difficult decisions can be implemented swiftly. In many cases, there is only a single firm controlling its vast oil wealth. Thus, Saudi Arabia, though it may have joint ventures with foreign firms, has full control over the entire Saudi crude oil production mechanism. The dictate to reduce production by 2.5 mmb/d is a (relatively) straight forward matter of recalibrating the Kingdom’s integrated production infrastructure. This applies to OPEC states as well, such as Kuwait, the UAE and Angola, where Kuwait Petroleum, ADNOC or Sonangol have tightly integrated crude production infrastructure where control of national output levels is centralised.

Even in countries within OPEC or OPEC+ where the industry is more competitive, this holds true. In Russia, Rosneft, Gazprom and Lukoil may all compete with each other, but they will not ignore an order from the Kremlin to reduce output proportionately in accordance to the supply deal. In OPEC countries such as Iran and Iraq, the small number of national producers makes collusion easier. This even applies in countries within OPEC+ where free market ideals hold more strongly. Petronas may not be able to dictate the output levels of PTTEP, Shell or ConocoPhillips’ Malaysian assets, but it owns enough control in key assets to influence the national output level. Ditto for Azerbaijan, Kazakhstan and Oman, even if the state oil firms there have extensive partnerships with supermajors such as BP, Chevron and Shell.

Adherence aside, it should be relatively easy for the OPEC+ club to meet their target of 9.7 mmb/d if the temptation to cheat doesn’t take hold. But what about the large free market producers? The pact between these countries and OPEC+ calls for the former to reduce production ‘naturally’ according to market pressure. That, again, is relatively easier for Norway and Brazil, where the reins of production are concentrated in the hands of Equinor and Petrobras. But what about the thorn in the oil industry’s side, the USA? There is no American state oil firm, and neither is there a federal body tasked to coordinate national output levels. It can happen on a state-level, like the Alberta state government in Canada or the Texas Railroad Commission – but players in these markets still cannot be compelled to follow through. The US oil industry is a matrix of many, many private players large, medium and small, each driven by a capitalist drive for profit, which is counter intuitive to controlling output.

So, in the absence of top-level control, each player in the US is left to their own devices to control their own output, in hope that each of its rivals will do the same to allow an optimal level of national output. A true expression of game theory. So what is going to happen?

Well, the first and quickest way to reduce output is to target onshore wells, particularly in the shale patch. This can happen voluntarily, or enforced through the growing number of bankruptcies. In North Dakota, where the shale revolution took root early, some 6200 wells have been shut, almost a third of all wells. Stopping wells temporarily is easy, but halting them forever is considerably tougher. So the question facing these producers is: which wells to shut, and for how long? For most, the target will be painted on newer wells, where the marginal cost to extract abundant oil is lower, essentially saving the crude for a better price. And running older, less productive wells, with the idea of closing those fully once the resources expire, rather than going through the expensive stop-and-restart process in newer wells. It is a strategy that supermajors ExxonMobil and Chevron have taken in the US shale patch, who announced that they would be slashing rigs in the prolific Permian Basin by 75% (to 15 sites) and 71% (to 5 sites) over 2020. Closures will be on the newer, more prolific wells – a testament to shale’s steep production drop-off curve and, as ExxonMobil put it, ‘better off deferring higher production rates into a period with better pricing.’ This strategy seems to be replicated across the American club of producers, from the giants to regional players such as Continental Resources. And once again, the American shale patch’s flexibility can run both ways, as easy as it is to close down an onshore shale rig (compared to a vast offshore rig), it is equally easy to restart them once market conditions change.

In April alone, estimates from the IEA show that the US, Canada and Brazil accounted for most of the month’s 2.2 mmb/d decline in production. That’s nearly half of what was requested of the free market oil producers. With the OPEC+ deal entering force in May and US oil prices in the doldrums, it would seem that there is enough political will and market pressure to enforce nearly 15 mmb/d of output cuts across the industry. That will go a long way to supporting prices in their current weak state. The hope is that this bitter pill won’t have to last long, and once demand improves and economies re-open, oil producers from across the spectrum will be able to return to business as usual. Or, at least, business as usual in the new normal.

 This article was first published on NrgEdge, your resource for industry news and updates. Visit NrgEdge today! - https://www.nrgedge.net/nrgbuzz

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