Uncertain times are upon us. Our jobs and way of life are being affected by the coronavirus pandemic and by the measures being taken to halt its spread. While these measures are necessary to suppress the spread, they are also suppressing demand for goods and services, and crippling key parts of our economy. Many families will soon feel a great deal of economic pain, if they aren’t already.
I’m not arguing against steps that have been taken, simply pointing out the reality of the situation.
One silver lining is that gasoline prices have plummeted to near record lows (adjusted for inflation). Low gas prices are usually great for jobs and the economy. I always advocate for energy that is both reliable and affordable. But this apparent positive carries dangers in the current circumstances. It feels great to fill up for less and less each day, but the companies that produce our energy cannot sustain these prices. Normally I would say that this is simply the reality.? The market will work itself out and the survivors will be those who can match their cost and supply to the price and demand.
But make no mistake, these prices are not market driven. For the first time in history, supply and demand have been simultaneously warped by forces completely outside of normal economic markets. On the demand side, fears of coronavirus have decimated our transportation demand.? Obviously, this is not a long-term market shift, simply a short-term response.? Estimates range from a 5 to 10 million barrel a day drop in demand around the globe, just due to this slowdown.? On the supply side, Saudi Arabia is using its spare capacity to challenge Russia for market share and force compliance with cuts. In doing so, they have stated that they will place an additional 3 million barrels per day of oil on the market, artificially cutting prices.? Between previous oversupply, drop in demand, and excess production on the market, it appears that the global oil market could be oversupplied by 10 to 15 million barrels per day, or roughly 10 to 15%.? On an annual basis, this is the highest level of oversupply in history:
YEAR OVERSUPPLY
| 1974 | 5.7% |
| 1971 | 4.7% |
| 2018 | 4.0% |
| 1973 | 4.0% |
| 2016 | 4.0% |
| 2015 | 3.5% |
| 1976 | 3.3% |
| 2014 | 3.2% |
| 2012 | 3.0% |
| 1972 | 3.0% |
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.