On May 4, a natural gas pipeline in Hillsboro Kentucky suddenly exploded, and for a brief but violent moment, American natural gas burned uncontrolled. The explosion in Kentucky serves as an apt symbol of the possible faith of US oil producers as they face the pinnacle of their existence.
A Texas Eastern Pipeline explosion in Hillsboro, Kentucky
As demand slowly improves, oil prices have risen—but the coming week’s expiring June contracts on WTI crude and the expected arrival of 44 million barrels of Saudi crude could spell doom for US shale gas production.
Cushing, Oklahoma, a major hub for US oil
Cushing as a microcosm
When entering the sleepy Oklahoma town of Cushing, just as you pass the large Walmart, trees on each side of the road block what could soon become an unprecedented American tragedy. The town, with a population of 7,826 and only one restaurant, is host to 91 million barrels of oil.
While there is plenty of space for new residents in the lush green area, the capacity for oil is rapidly filling up. In the coming weeks, the large fields of white oil tanks are expected to reach “tank tops,” meaning the sprawling tank farms in the area will be filled to the brim, with nowhere for oil to go.
Cushing functions as a hub for the flow of oil for many of the oil-producing states and could become a microcosm of an industry that has faced a sudden blow that could prove fatal.
Shale gas pioneer Chesapeake Energy is on the verge of bankruptcy
A pioneer crumbles
An indication that the US shale gas industry is in trouble came on May 11 as one of the pioneers that popularized US shale gas, Chesapeake Energy, announced it is evaluating bankruptcy.
Its senior executives have “pre-paid” themselves bonuses worth $25 million, as the captains are clearly not interested in going down with the metaphorical ship.
Chesapeake Energy was one of the companies that helped propel shale gas as a strategy to make the US the top producer of oil globally. Chesapeake had already stumbled in 2019, but the unprecedented drop in oil prices due to plunging demand has proven too much to bear.
The company holds $9.7 billion in debt while the product it sells is making a loss and banks are unable to provide a lifeline as they did during the 2014 oil price collapse.
Oil wells are increasing being shut-in
Plummeting prices and negative outlooks have resulted in a wave of “voluntary” production cuts. Shale giant Continental Resources is cutting 70% of its production as US oil producers are on track to cut 1.7 million barrels of oil production per day.
While large oil producers have the option to limit production by shutting-in some wells, or schedule maintenance in the coming weeks, smaller producers have no choice but to continue pumping up their loss-making product.
Small producers are often unable to close their wells because of possible damage to their assets and the financial costs involved in both shutting and reopening wells. Shale gas production relies on a constant stream of pressure, making it especially difficult to effectively halt production.
Some of the larger oil players, meanwhile, are abandoning US shale gas assets. Supermajor Shell, known for its long-term perspective, just sold its Appalachian shale gas fields for 10% of what it paid for the assets in 2010.
An oil tanker near the Saudi-owned Port Arthur refinery
Conclusion to a decades-old oil war
What might seem like a sudden and unexpected shock to US producers, in Saudi Arabia it is the logical conclusion to two decades of competition with growing American market share. Some US senators have accused Riyadh of not “acting like a friend,” but in the free-market, there is no such thing as friends.
The US emphasis on free markets means that they are limited in their options to respond. The Saudis own the largest refinery in the United States, and according to the free market, there is no issue with them unloading their oil in US ports or selling that oil at a loss. And it appears that this is exactly what the Saudis intend to do.
Oil tankers wait off the coast of California
Industry experts at Rystad Energy say that within two weeks, a Saudi tanker fleet carrying 44 million barrels of oil is set to flood the American market that is already bursting at the seams. The oil the Saudis plan to dump could completely offset the US production cuts it has painfully realized over the last month.
The Saudis are unlikely to make even a penny on their crude—instead, they are buying the demise of a competitor.
Trading in futures could again significantly impact oil prices like it did in April.
Timing is everything
With the Saudi fleet scheduled to arrive before May 24, and June futures contracts expiring on May 19, the moment Saudis are able to flood the market could prove key.
If the Saudi tankers, especially its VLCC’s (Very Large Crude Carriers), manage to make it to American deep-sea ports before May 19, they could flood the saturated market just as investors scramble to offload June futures. The sudden flooding of the US market could cause US oil prices to once again dip into the negatives as they did in April.
If the timing is “right,” the Saudis could do untold damage to their American competitors, cause a collapse of US shale gas production, and increase their market share for the long-term. US President Donald Trump has tried to intervene, but promised Saudi production cuts will do little to stop their fleet from causing what some experts have called an “economic Pearl Harbor.”
US troops moving Patriot missile systems
The Saudis last chance
The Saudi gamble might appear extremely risky as it threatens its military alliance and friendly trade relationships with the world’s largest economy and greatest military power.
But for Riyadh, the current crisis is their last chance to intervene. As some shale gas companies have used their profits to diversify into producing oil, the Saudis had one opportunity left while the shale gas industry is still fully dependent on shale gas extraction and burdened by high debts.
As an example, Chesapeake Energy was trying to pivot to a greater emphasis on oil production over shale gas, but now will be unable to do so as it faces bankruptcy. Before demand increases again as lock-downs are lifted, the Saudis need to make their move.
Before shale profits allow the companies to ironically wane itself of a reliance on its primary product, the Saudis appear to have chosen to strike. With a week left until futures expire, and the Saudi tanker fleet on its horizon, the coming weeks might produce the beginning of a fundamental restructuring of global oil production.
The coming weeks could spell doom for US producers. For other countries that depend on oil revenue, however, the US collapse could produce exactly the drop in production that could result in an end of a crisis in global oil prices, just as demand starts to pick up.
Crude Oil prices going up as Saudi Arabia cuts production levels. Our great Energy Companies, with millions of JOBS, are starting to look very good again. At the same time, gasoline prices at record lows (like a big Tax Cut). The BEST of all Worlds. “Transition To Greatness”
— Donald J. Trump (@realDonaldTrump) May 12, 2020