Texas is home to the Permian, the highest-volume producing basin in the world’s highest-volume oil producing country. Industry contacts told the Dallas-based Eleventh District of the US Federal Reserve that they expect capital spending in the US oil and gas sector to be down as much as 20% in 2020. The Dallas Fed went on to say that it expects a year of “restructurings, consolidation where possible, and general belt tightening,” particularly among service companies.
Dallas Fed economists expect 2020 US crude production growth of 400,000 b/d, compared with 2.0 million b/d in 2018 and 900,000 b/d last year and assuming West Texas Intermediate crude oil prices of $50-60/bbl.
Global demand has softened as an already oversupplied market grapples with the potential effects of the coronavirus (COVID-19). In January 2020, before the virus crisis deepened, the International Monetary Fund forecast China’s gross domestic product (GDP) growth slowing from 6.1% in 2019 to 6.0% in 2020. On this basis, a 0.1 percentage-point slowdown in economic growth, the International Energy Agency (IEA) forecast a 31.25% year-on-year drop in China’s oil-demand growth to 440,000 b/d.
China’s GDP growth fell one percentage point in 2003 during the SARS outbreak. OGJ forecasts that if the Wuhan coronavirus follows a similar path and China engages in similar economic stimulation in its wake, its GDP growth will drop to 5%. If, however, the Wuhan virus expands out of control, China’s 2020 growth will slow to 2%.
And China’s role in the world economy has only expanded since 2003, when its activity made up 4% of global GDP. It now comprises 17%. China’s oil consumption was 14% of the global total in 2019, according to IEA, and its consumption growth accounted for 57% of the worldwide increase.
IEA expects first-quarter oil demand to drop 435,000 b/d compared to the same period a year ago, the first quarterly decline in global demand in more than a decade. Consultant Rystad Energy said that “the economic slowdown in China will cause the largest negative oil demand shock since 2008.”
Continued discipline
The Organization of Petroleum Exporting Countries plus 10 cooperating nations (OPEC+) have shown unprecedented discipline in attempting to trim production in the face of diminished demand growth. Cuts of 1.8 million b/d implemented in January 2017 are still in place (currently through Mar. 31, 2020) and have been adjusted or expanded in response to subsequent events.
Crude prices dropped 4% Feb. 24 as new cases of COVID-19 were reported in South Korea, Iran, and Italy. OPEC+ had already (on Feb. 6) proposed an additional 600,000 b/d of production cuts to address virus-related demand concerns, but Russia has yet to agree. Analysts expect demand to improve rapidly once COVID-19 is contained, but there is neither clarity nor consensus regarding when this might happen.
As operating companies and service companies alike began 2020, they were already preparing to exercise capital discipline. With the drag on demand deepening, however, and oil and gas prices being pressured along with it, this discipline will become even more crucial.
The industry has spent the years since the 2014 oil price collapse improving its efficiency. Yes, the dynamics of shale development and production (quicker returns, shorter timelines, etc.) have helped in this regard. But efficiency increases have also been realized offshore, where return-on-investment is still an extended proposition.
With uncertainty surrounding both continued supply restraint and the depth and duration of demand destruction, industry’s new practices are facing their first real stress test. As prices fall, temptation to take drastic action will mount. Resist this. The current market weakness will pass and the successful path forward has the same components that brought the business to this point: discipline and innovation.