HOUSTON — The American oil industry may have dodged a bullet.
Russia and Saudi Arabia — which only a month ago hoped to undercut American producers — have retreated from threats to pump more oil into the already-saturated market. Acknowledging that the gamble was hurting themselves as well, they instead announced this past week that they had tentatively agreed to cut production.
The change in course would give American companies room to gradually reduce production on their own terms, without government or regulatory mandates, as they invest far less in exploration and production.
“The American oil industry has avoided a worst-case scenario,” said Amy Myers Jaffe, an energy and Middle East expert at the Council on Foreign Relations. “There still will be bankruptcies, but for the time being, the fears that there would be a wholesale destruction of the industry can now be put aside, because the worst of the price war has passed.”
What happened in recent days may support an industry that directly and indirectly employs nearly 10 million Americans. The surge in U.S. production in recent years has reduced dependence on foreign oil, and lowered prices at the gas pump for consumers.
Uncertainties remain for the industry. Virtual summits of oil-producing nations and Group of 20 energy ministers on Thursday and Friday ended with some ambiguity, when Mexico balked at an agreement fashioned by Russia and Saudi Arabia to collectively reduce production by 10 million barrels a day. But the two oil powers appeared ready to give Mexico a pass, after President Trump made a vague promise that the United States would make the cuts its southern neighbor refused to make.
Members of the Saudi-led Organization of the Petroleum Exporting Countries had entered talks hoping that the United States, Canada and other western producers would agree to explicit cuts, adding up to another 4 million or 5 million barrels a day. Instead, American officials just made assurances that crude output would be reduced over time, on top of voluntary reductions that have already begun at some U.S. companies.
The global oil industry still has many problems. The collapse in economic activity caused by the coronavirus has reduced demand by an estimated 30 million to 35 million barrels a day, according to international energy agencies and oil consultants.
Analysts expect oil prices, which soared above $100 a barrel only six years ago, to remain below $40 for the foreseeable future. The American oil benchmark price was just under $23 a barrel on Thursday.
But a complete free-fall of oil prices into the single digits — something not seen in two decades — appears to have been avoided. President Trump’s recent public lobbying of Russia and Saudi Arabia to lower production helped raise prices several dollars a barrel, allowing many American companies to reduce their exposure to dropping prices by hedging. By fixing their sale prices at a higher level that was closer to break-even for shale wells, they were able to limit their losses.
American oil companies are already eliminating thousands of jobs, plugging old wells and decommissioning rigs and fracking equipment in preparation for the worst downturn in more than a generation. Oil-producing states like Texas, Oklahoma and North Dakota are expecting deep losses in jobs and tax revenue.
Falling demand for oil around the world may cause American oil exports, which reached more than 3 million barrels a day last year, to dry up almost completely. Concerns about climate change will continue to dog the industry and scare away investors.
But industry executives predict consolidation, in which small, indebted companies are either bought by larger ones or merge. Drops in production will come as market conditions of supply and demand dictate. American oil production has already fallen several thousand barrels a day over the last two months and will probably decline another 2 million barrels a day through the end of the year, according to the Energy Department.
”There will be some companies that won’t survive,” said Trent Latshaw, president of Latshaw Drilling, an oil service company active in Texas and Oklahoma. “But the industry in general will survive and come out of this stronger. We will have to make hard decisions, innovate, and we’ll become smarter because of this.”
The scenario is similar to the last time Saudi Arabia and its OPEC allies flooded the market with oil in 2014 in an effort to undercut American shale producers who were taking market share away from them. Prices crashed and hundreds of American companies went out of business, and 170,000 jobs were lost. While American production briefly dropped, it quickly recovered and grew.
The coronavirus is a new and bigger challenge to the industry, and that challenge was briefly magnified when Russia last month refused to go along with Saudi Arabia in cutting supplies. Russian oil executives said they were tired of losing market share to American producers. Saudi Arabia retaliated by promising to pour more oil on the market, taking prices to roughly $20 a barrel for a time, less than half the level at the beginning of the year.
The decision by Saudi Arabia to put an additional 3 million barrels a day on the market was a huge gamble that backfired, and it is possible oil prices will sink again in the coming days if traders are not satisfied with the cuts announced by Saudi Arabia, Russia and their alliance partners. In fact, on Thursday, the last day that oil futures traded, the price fell sharply even though the producers were close to a deal.
Behind all the blustery wheeling and dealing, Saudi Arabia did succeed in bringing Russia back into the fold of an alliance of producers called OPEC+. But caught off guard by the size of the price drop, both Saudi Arabia and Russia needed to reverse course and make supply cuts to prop up crude prices.
“There were miscalculations on both sides,” said Ben Cahill, a senior energy fellow at the Center for Strategic and International Studies. “The Russians miscalculated how sharp the Saudi response would be and they might have been taken aback by how deep the price drop was.”
“Saudi Arabia will have big budget deficits, they’ll have to issue a lot more debt, they’ll need to run down their reserves, and the longer this cycle goes on, the more destructive it is,’’ Mr. Cahill added.
With the pandemic crushing economies around the world, few buyers were available in recent weeks to buy the cheap Saudi crude. The kingdom stored some oil in Egypt and was forced to let unsold crude sit in tankers along its coasts.
The mounting glut became a threat to Saudi government finances. At a projected average price of $34 a barrel this year, the Norwegian consultant Rystad Energy estimated, the kingdom’s revenues would be 50 percent lower than in 2019, a loss of $105 billion.
Saudi Arabia still has foreign reserves of $500 billion, but that has shrunk from $740 billion in 2013. Several years of depressed oil prices forced the kingdom to borrow money and reduce energy subsidies for its citizens. Crown Prince Mohammed bin Salman is now counting on his reserves to help diversify the Saudi economy for the future.
Russia is in far better shape financially than Saudi Arabia, especially with a flexible exchange rate — as the ruble depreciates, the value of its exports rises. While it would also lose billions of dollars in revenues with the drop in oil prices, the government has a much lower fiscal deficit than Saudi Arabia and has $550 billion in foreign reserves.
But Russia has other liabilities. It has limited processing capacity and its refineries have insufficient storage facilities. It relies on long pipelines to take its oil to European and Asian buyers. But European demand has collapsed, and Russia’s storage tanks are quickly filling. China is still buying oil, at bargain prices, but its storage will be filled up in another month or so, leaving Russian crude stranded.
With thousands of Soviet-era oil and gas wells in western Siberia, Russia would be faced with the prospect of shutting down and later turning back on wells, an expensive proposition, and in the process might permanently limit the amount of oil recoverable in the future.