With the oil market choking on crude it cannot sell in a crashing global economy and a financial market punishing the big-spending ways of oil companies, it is becoming more likely that governments will intervene to keep U.S. oil and gas companies operating, experts said.
Responding to the coronavirus-induced oil market collapse, a conservative Trump administration has brokered a deal with OPEC to prop up prices, committed to buying oil for the Strategic Petroleum Reserve, contemplated tariffs on imported oil, backstopped junk-rated debt and floated a proposal to keep oil in the ground. Meanwhile, lawmakers from Appalachian shale states are putting pressure on the U.S. Treasury Department and Federal Reserve to give heavily indebted shale gas drillers access to coronavirus relief funds to pay immediate interest payments.
"Government's getting stronger and oil is getting weaker," Kevin Book, managing director at energy policy analysis firm ClearView Energy Partners, said in a recent interview. This year marks a "secular shift from a free market to a government-managed market," Book said.
Many in the oil industry do not want government intervention. During a hearing in Texas for the state's energy regulator to consider oil production limits, executive after executive lined up to say the free market should be allowed to operate, and low prices will take care of low prices. Even though U.S. oil futures prices turned negative April 20 for the first time ever, many big shale oil and gas producers are protected from low prices by hedges in 2020, and many refinanced debt in recent years to put off debt coming due.
Economists also maintain that the market is more efficient in the long run, but policymakers and politicians do not have a long run; they have unemployed constituents. "People vote, not companies," Book said. "Governments have lost patience with the market."
While the idea of operating under some government supervision may be anathema to the industry's self-image as wildcat drillers ready to let their bankrolls ride on the next well, it is worth remembering that the OPEC cartel was modeled after the Texas Railroad Commission. The commission, for the first time in nearly 50 years, is considering controls on the state's oil production.
"We will never let the great U.S. oil & gas industry down," President Donald Trump tweeted April 21. "I have instructed the Secretary of Energy and Secretary of the Treasury to formulate a plan which will make funds available so that these very important companies and jobs will be secured long into the future!"
Hedges protecting profits for 2020
On paper, the big U.S. exploration and production, or E&P, companies are in a strong position to book large cash flows this year. An S&P Global Market Intelligence analysis of large shale oil drillers showed that most have the bulk of their production hedged well above NYMEX futures prices for 2020. When combined with steep cuts in spending and drilling, those companies could be generating the free cash that investors have been clamoring for since the last price crash in 2014-15.
While those hedges offer financial protection, if storage fills and customers refuse delivery, the banks and other counterparties will pay off in 2020 but will be wary of selling much price protection for the rest of this year or the next, analysts said.
"Absent a rally in crude, we doubt any additional oil hedges will be added over the next six months (little late to insure the Titanic)," Raymond James & Associates oil and gas analyst John Freeman told clients in March. "While there is still ample time to add hedges, given the current commodity environment, a big haircut will have to be taken on the  strike prices compared to 2020."
Adding to the pressure on policymakers, the clock is ticking down toward no more room in the tank. NYMEX crude oil futures prices for May delivery plunging into negative territory April 20 indicated that storage space is hard to find and that the market expects it to top out soon. Negative prices would mean producers have to pay customers to take their crude to avoid damaging their reservoirs.
"Some producers which are high cost may have hedges in place which means that they are indifferent to how low oil prices go and will keep producing," Sanford C. Bernstein & Co. oil analyst Neil Beveridge told clients April 17. "Prices can fall further to make further storage attractive, but if there is no place to put the oil, then there is no limit to how far prices can fall in the short term." Bernstein estimated storage will fill in the next five to 16 weeks.
"Will we hit -$100/bbl next month? Quite possibly," Mizuho Securities USA analyst Paul Sankey said in an April 21 note. "We have clearly gone to full scale day-to-day market management crisis, and as we said when we first called for negative prices, the physical reality of oil is that it is difficult to handle, volatile, potentially polluting, and actually useless without a refinery."
Wall of debt on the horizon
If the price protection of hedges keeps E&Ps alive to fight another day, many of those companies could be swamped by a wave of debt coming due beginning in 2021 unless the economy and demand for oil recover.
Nearly $38 billion is coming due through 2021 from the E&P and oilfield services sectors, according to S&P Global Ratings. Whiting Petroleum Corp., most active in North Dakota's Bakken Shale oil play, became the first big shale oil driller to file for Chapter 11 protection earlier in April.
"This price downturn ... I think that's going to make an 'industry sort of bouncing back with gusto' scenario, which some people say they see for 2022, really hard," Sarah Ladislaw, director of the Energy Security and Climate Change Program at the Center for Strategic and International Studies, said in a recent interview. "The bankruptcies that one was sort of imagining would happen over the next six months sort of truncated into a much smaller window of time."
The markets are worried about defaults spreading in the oil and gas industry. Oil service companies that do the drilling and fracking are at the top of a list of concern, according to Market Intelligence's market signal probability of default measure April 20. The probability of default measure, a combination of stock market activity and finance fundamentals, began spiking higher in early March as coronavirus demand destruction began to outstrip the decline in oil prices caused by the supply shock of Russia's oil price war with Saudi Arabia.
Recovery unlikely without demand
"There's a lot fewer players a year from now. For individuals who work at those companies, that's a problem," energy futurist Jason Schenker told Market Intelligence. "That being said, companies that can spread their [operating expenses] across a broader range of assets and increase efficiencies of scale ... it might be 'more efficient.'"
It is that job-killing efficiency that worries policymakers and politicians, who might be guilty, with their focus on propping up prices, of fighting the last war. The cure to what ails the oil and gas market is increased demand, and that means the economy as a whole has to get better, analysts agreed.
"As long as we don't have [a coronavirus vaccine or effective treatment], we will have to do a certain amount of distancing and a certain amount of reducing our activities," University of Virginia economics professor Anton Korinek said in an April 14 interview. "In particular, reducing high-risk things like travel, because those are the ones that spread the disease most easily. And those are also the ones that consume the most oil," said Korinek, whose research focuses on the future of work.
Korinek expects demand to remain depressed for a year or more, increasing only when a coronavirus vaccine is developed. For crude demand to come back, a host of other economic activities have to return after workers and consumers are assured of safety from infection, experts agreed. Those factors include:
* The end of lockdowns and a return of retail and hospitality employment.
* A return to work at offices and factories, implying an uptick to gasoline consumption.
* Freedom to travel without fear, which helps air travel recover and increases jet fuel consumption.
Schenker worries that some oil demand will go away permanently. "The remote working prospects have long been my biggest concern for long-term oil and gas demand destruction, so if we see more companies implement remote working on a permanent basis ... we could see that there might be long-term demand destruction impacts that would keep oil prices under further pressure," Schenker said.
The longer the pressure lasts on the sector, the more involved the government may have to be, according to ClearView's Book. "You are going to start to see oil and gas on the government's balance sheet. ... As Fed takes warrants and makes equity covenants ... it's going to be a long workout," Book said. "The thing that makes oil and gas so productive doesn't compete with what we see now: catastrophic contraction and unprecedented demand destruction."
The credit and equity markets were ready to flush smaller companies with weak balance sheets before the coronavirus crisis emerged, analysts said. Government intervention is now the wild card and looks more likely.
"We have long since entered the zone where previously unthinkable policies have become possible, such as any of the following disruptive risks: A breakdown of the U.S.-Saudi strategic relationship, U.S. oil tariffs on imports from [Gulf Cooperation Council] or OPEC+ countries, or U.S. government subsidy paid to oil companies not to produce," Deutsche Bank oil analyst Michael Hsueh said April 20. "Further OPEC action may not be forthcoming because the decision to reduce output in May is already stretching the limits of both what is operationally possible, fiscally acceptable, and plausible to market participants."
Some in the industry are beginning to wonder what the other side of the oil and gas downturn looks like.
"We have to preserve these islands of competence and of competition, because if we ever want to have something like an energy transition, if we ever want to move away from fossil fuels, we need that power to innovate," Christof Ruhl, former BP PLC group economist and now a scholar at Columbia University's Center on Global Energy Policy, said during an April 21 webinar. "It cannot be done by fiat or by governments. If we now protect the fossil fuel sector and let them slide into a protected future where market shares and prices are the subject of backroom negotiations, that would be exactly the wrong way to do it going forward."
"Our industry has created such economic waste that nobody will buy our stocks or own our stocks," Pioneer Natural Resources Co. President and CEO Scott Sheffield told Texas regulators as he pushed for production limits in Texas. "Nobody wants to give us capital because we all destroyed capital and created economic waste."
Sheffield's outlook may explain why he is among the vocal minority shouting for government assistance. Pioneer has increased oil production more than three times since 2012 to 212,350 barrels per day last year, but only posted positive cash flow once during that time period, in 2019.
"The biggest question I've got is whether investors will see the oil and gas sector as something they want to invest in again," Ladislaw said.