High Stakes for the U.S. Response to Global Market Shifts

Dean Foreman
Posted March 12, 2020

Global oil markets have shifted dramatically in recent days and weeks, and the stakes are high for the United States energy revolution, retirement savings and the broader economy.

Let’s start with crude oil prices. Per Bloomberg, the per-barrel price of West Texas Intermediate (WTI) on March 9 was about half of what it was on Dec. 31, falling to $31.13 from $61.06. 

1. How did this happen?

The downturn in oil prices is a combination of 1) lower short-term demand due to global measures to stem the spread of the coronavirus (COVID-19) coupled with 2) oil supply increases recently announced by Russia and Saudi Arabia. The actions by the two major suppliers – leading competitors to the U.S. on the global crude market – create what could be a critical juncture for the shale-driven U.S. energy revolution.

2. What does this mean for Americans?

To be clear, low oil prices provide a short-term benefit for consumers, who are already saving billions of dollars on energy costs. And there’s reason to be confident that long-term oil demand will remain resilient as the COVID-19 demand shock fades. 

Yet, there’s no sugarcoating the challenges that immediate, unexpected and discontinuous market shifts present to producing companies, their employees and the states and communities where they live, all of which are vital to the U.S. economy and energy value chain. 

3. How are policymakers reacting?

There are reports that the White House is considering measures, including potential loans, to support energy companies hurt by these market developments. To be clear, the industry is not advocating for any form of policy relief at this time, and instead remains focused ensuring the free-market works.

4. What do past events tell us about the current markets?

The International Energy Agency (IEA) has lowered its 2020 forecast by a range of 480,000 barrels per day to as much as 730,000 barrels per day. On the high end of this range, global oil demand could decrease for the first time since the 2008.

History indicates the current conditions of the global oil market will likely be temporary. Global demand has remained robust across decades of economic cycles and geopolitical events, including the seminal oil market events in the 1970s-1980s and every recession since then including the Great Recession in 2008-2009. The intertwining of economic growth and oil demand growth also remained solid throughout 2019.   

5. How will this impact the long-term demand for energy?

Looking forward, official agency projections of the world’s need for natural gas and oil is substantial under virtually any scenario. 

Whether we look to the IEA or the U.S. Energy Information Administration (EIA), which bracket a wide range of long-range economics and energy scenarios, natural gas and oil should continue to supply half or more of global energy demand for decades to come. These fundamentals reflect the enduring need for energy to support human and economic development – as well as the sheer enormity of global energy systems, infrastructure and transportation fleets on the road, in the air and on the sea. 

6. How will America’s energy industry fare in the long-term?

The U.S. has an abundance of natural gas and oil resources and production, thanks largely to technological innovations like hydraulic fracturing, horizontal drilling, 3D imaging and advanced data analytics. These innovations have made domestic natural gas and oil competitive and have corresponded with U.S. leadership in global production in January with 13.0 million barrels per day (mb/d) of crude oil production, plus another 5.0 mb/d of natural gas liquids (NGLs) by API estimates and 95.4 billion cubic feet per day of natural gas per EIA. Total U.S. petroleum exports also reached a record 9.0 mb/d at end of 2019.  

Importantly, there’s much more to this than record quantities. Virtually all U.S. oil and NGL production growth is high-quality crude oil that is light in viscosity (measured by its API gravity) and low in sulfur (that is, “sweet”). Qualities of crude make U.S. oil well-suited for relatively simple and low-cost refining processes globally, as we discussed here.   

7. Is U.S. crude still competitive in the import/export marketplace?

When we look at refining capacity and its growth around the world, Asia Pacific and especially China and India are the fastest-growing markets, with the most voracious appetites for light crude oil. Despite trade frictions in 2019, Asia Pacific still purchased a disproportionate (42%) share of U.S. crude oil compared with the region’s share (34%) of global refining capacity. Historically, U.S. exports are in high demand in this region.

However, these are the very same high-growth markets that Russia and OPEC are aiming to serve. In a competitive market, economic fundamentals suggest that a negative demand shock like the coronavirus may result in lower prices – and it has.  Similarly, as producers adjust to the shock, their drilling activity and supply may eventually fall in response -- and U.S. drilling fell cumulatively by 25% over a period of 14 consecutive months, from December 2018 through February 2020.  However, the U.S. achieved production records for crude oil, natural gas and natural gas liquids (NGLs) due to productivity gains and new pipeline infrastructure, which are a testament to the innovation and strength of the U.S. energy revolution.

8. How are OPEC+ nations responding?

By contrast, OPEC and Russia announced production increases starting in April 2020.  Higher production in the face of lower prices runs counter to the response that one would expect by economic fundamentals. Apparently, this is the beginning of a “price war” among OPEC nations and Russia, but their actions could be rooted in an attempt to claw back the hard-earned market share that the United States has won over the past decade. 

9. How could a “price war” impact U.S. businesses?

Critically, what hangs in the balance now for the United States is trillions of dollars in existing energy infrastructure and investments, plus billions more in capital projects construction.

A glance at the U.S. energy sector’s recent financial reports – nearly 200 companies that span the energy value chain – showed that the upstream (resource development), midstream (pipeline transportation and processing), oil services, and engineering, procurement and construction (EPC) segments each generated increasingly positive operating cash flows over the course of 2019. Basically, they attempted to live within their means and build a cushion in a relatively low price and margin business climate – just not the extreme one that has played out in early 2020.

In the fourth quarter of 2019, companies across the natural gas and oil industry, on average, held cash equal to about 40% of their liabilities that would come due in 2020. For a household, that’s like a having enough savings to cover about five months of costs as a contingency against a breadwinner losing their job.

For most companies, however, the so-called “opportunity cost” of holding idle cash that could otherwise be used in the business can be high and possibly make the firm a takeover target. Investors also generally want excess cash returned to them through dividends or share buybacks. For these reasons, most firms hold just enough cash as needed for smooth operations, and they rely on revolving credit facilities to manage the rest. 

However, credit facilities can dry up during an economic downturn, and that is what we have seen as the estimated credit default risks for companies across the sector rose by more than 40% in past few days to more than double what they were last year. 

Additionally, the U.S. natural gas and oil industry – not including upstream resource development – is in the process of constructing $344 billion in new capital projects, according to API estimates.  These are investments that can enhance America’s energy production and exports for decades to come. That said, the industry is most vulnerable when it is investing, but not yet operating or earning income from proposed projects.

10. From API’s point of view, what is the short-term industry outlook?

API firmly supports free-market principles and competitive market outcomes. It’s also apparent that the immediate crunch many companies are experiencing – with the compounded effects of economic demand shocks from coronavirus and the potential damage to our nation’s energy security as a result of actions by Russia and Saudi Arabia – is a serious challenge.

We’re experiencing the collision of global market competition, geopolitical aggression, and uncertainties surrounding U.S. production, infrastructure and exports.  While we can confidently state that global oil markets will evolve to serve anticipated shifts in demand, and remain resilient along with the economy, the stakes for the U.S. energy revolution are structural, complex and important to the U.S. economy. 

We continue to monitor the markets and look forward to sharing updates on these critical developments.