Bryan Preston

Introduction

This brief updates the economic model I released last week detailing COVID-19’s impact on global oil markets. As there continues to be much speculation about actual global demand for oil during this downturn, most public numbers are based on estimates. The models that we have created are based on historical driving levels by country, and the relative amount of people who are covered under shelter in place orders.

Key assumptions in our analysis are:

1. A consistent ratio of work/commute driving and non-work/commute driving.
2. Virtually all oil demand loss is due to individual passenger vehicles and airlines. As a result, the portion of global demand is being modeled almost entirely on the portion of oil that is being refined into gasoline and diesel for individual vehicles, and jet fuel.

This update does not cover the foundational methodology of the model. That information was provided last week in a webinar that can be viewed here.

Additional data added to the model since last week includes:

1. Production cuts from areas such as the United States, Canada and Brazil as producers have voluntarily reduced rates due to low prices and warnings from buyers to reduce production.
2. Reduced storage volumes and rates at which regional storage is filling.
3. Changes to economic impacts based largely on unemployment updates, such as the US increase of 6.6 million last week.
4. News of China beginning to lighten restrictions in certain areas as COVID-19 in that country is beginning to wane.

Production

Based on reports from operators, regulators, and midstream companies, it appears that supplies have dropped slightly from recent highs. We estimate global production to have dropped 1.5 million barrels per day in the last week.

Demand (current)

Since last week, there have been slight additions to the number of people covered under stay at home or shelter in place orders. However, reports are that people are increasing compliance with these orders. Finally, unemployment levels are increasing dramatically in certain areas. To balance that, it appears that demand is beginning to increase in China, as stay at home orders are being lifted, although this is very early data. All together, we estimate that demand has dropped just below 78 million barrels per day (mbpd).

Figure 1 shows the updated global supply/demand curves, and the current oversupply of 24mbpd, relative to historic levels (this is an increase from 17.9mbpd in last week’s analysis).

Short-Term Issues

We estimate that at current US oversupply levels (4 to 5 million barrels per day), US storage will fill up in roughly two months, with the first area (mid-continent) to be at full capacity in mid-May.

Once storage is full, US oil production will have to match real time consumption levels. Given that US refiners require a heavy/sweet mix of approximately 2 to 1, this means that US refiners will be running approximately 10 mbpd of light sweet crude (WTI). Between contracts to bring some of this crude in from overseas, and high inventories to be drawn down. We anticipate that US oil production will drop to 8 to 9mbpd after oil storage is full.

Demand Projections

Demand levels are driven down both due to people working from home, and massive unemployment. Our assumption is that demand will go up almost immediately for those who are working when the Shelter-In-Place lifts. However, the demand will return slowly as people who lost their jobs take time to return to the job market. Therefore, the longer that people shelter in place, the more layoffs occur, the longer it will take for demand to return.

Figure 2 shows our updated demand projections based on when the majority of orders to Shelter in Place are lifted in areas of high oil consumption such as China and the United States.

The important conclusions include:

• If SIP orders are lifted in May, then demand should return to normal levels in September, 2020
• If SIP orders are lifted in June, then demand should return to normal levels in June, 2021
• If SIP orders are lifted in July, then demand should return to normal levels in November, 2021
• If SIP orders are lifted in August, then demand should return to normal levels in August, 2022

Watch my previous supply & demand webinar here.?

Over the course of 1971 through ’73, the global oversupply drove oil prices down to an inflation adjusted $20 per barrel. By 1974, the Middle East oil embargo disrupted the flow, caused domestic (WTI) prices to spike, and global oversupply went to the highest level on record in 1974. The last ten years have seen the next wave of oversupply, as the world’s demand for energy from oil and gas has projected a continuous climb. However, never have we seen oversupply levels where they are today. As a result, there is a surplus of oil that could be hitting the market in the coming months as high as 1 to 1.5 billion barrels. This will far exceed available storage in the world, which may drive oil prices to the lowest price, adjusted for inflation, in history and force producers to shut in production and cut off necessary cash flow to remain in operation.

Due to the shale revolution, United States became 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 to 6 million barrels of oil per day over the next few years. This threatens American energy independence and could return our country to the days where wars in the Middle East wreaked havoc on our economy.

Texas is the world’s third largest oil producer. The oil price war endangers our 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 of South Texas as companies are shutting down their drilling rigs. The United States and Texas stand at a disadvantage in one respect. Both the Saudi and Russian governments control their oil production, while the United States operates a free and open market.

I know how that sounds. I am a free market capitalist. Free markets have made the United States the strongest and most prosperous nation in history. In contrast, state-run economies never work. Venezuela was once one of the most prosperous economies in the western hemisphere, but under statist socialism, it has become a humanitarian and economic disaster. Free markets work.

All of that said, we are at risk. In the short run, we are at risk that a key part of our economy?our energy sector?goes through a dramatic downturn. In the long run, there are even higher risks that the energy supply will be disrupted when demand returns. If US oil production drops by 3 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 $4.00 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 the demand comes back, how can we be ready to move fast to fill it even though we may be slowing down in the short term?? 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 Texas and the United States 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. Ask any economist. 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 leadership to broker the discussion 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 proration schedules, thereby limiting production for Texas producers. It has not been used since 1973, when OPEC was formed and began controlling swing production. In theory, Texas could cut production by 10%, and if Saudi Arabia is willing to cut 10% from its pre-COVID-19 levels, and Russia is willing to do the same, it would put the market back to the level it was (somewhat oversupplied) before the current crises. While Texas controls its destiny, we don’t control others. We would need our federal government, and our president, to make the deal that stabilizes oil markets. President Trump did write the book on deal-making.

To be clear, I abhor government intrusion into the free market. But, with other governments already manipulating oil markets it’s fair to ask, “Why shouldn’t our government step in to try and 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 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 proration for Texas producers is appropriate if it can return the world back to the market. I would love to hear what leaders from industry, environmental groups, and consumers think about our options.

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, and Texas.

Ryan Sitton was elected to the Texas Railroad Commission, which regulates oil and gas production, in 2014. He built his thriving reliability company, Pinnacle, formerly PinnacleART, in his garage in 2006. Today it ensures engineering safety around the world. He is Texas A&M’s youngest ever Distinguished Graduate of its College of Engineering and is the first engineer to serve on the RRC in over 50 years.

Each year I author the Energy Market Outlook, an in-depth analysis of current global energy markets and predictions for the remainder of the year and into 2020. This report examines crude oil, natural gas, and key environmental trends related to energy markets, such as emissions and flaring information. It is based on both historical data from various resources, including the International Energy Agency and U.S. Energy Information Administration, as well as extrapolated data from my own analysis.

Click here to get your free digital copy of my 2019 Energy Market Outlook.