The Fuse

Oil Shut Ins Grow. Some Supply Won’t Come Back

by Nick Cunningham | May 11, 2020

Oil prices have doubled in less than two weeks, with WTI in the mid-$20s. There is a general sense that the oil market is passing the deepest point of the downturn, with demand starting to increase ever-so-slightly.

Supply shut ins are also playing their part. A meltdown in the market, including a brief trip into negative territory, has forced desperate action. The pain is not yet over.

Oil supply shut ins grow
Across the globe, there are a few oil producers that can grow production at current prices. Supply curtailments hit different producers in different ways, with those landlocked and farthest from storage most acutely at risk of disruptions.

But nobody has been spared. “When it comes to the where, why and how of production cuts, the wide range of technical, logistical, regulatory, contractual, and financial conditions means there is no single set of answers,” Paul Markwell, vice president, global upstream oil and gas, IHS Markit said in a statement. “But under these market conditions, it is pretty clear where production will be cut. Nearly everywhere.”

The U.S. oil rig count has declined by 391 since mid-March, a decline of nearly 60 percent in two months. The Permian basin has lost 220 rigs over that period.

Meanwhile, some more marginal places are also getting hit, with the idling of their very last rigs. “Last week, North Slope in Alaska, Walker Ridge in Louisiana, and Ellis County in Oklahoma saw the departure of their last active rigs,” Rystad Energy said in a report. There are now just 46 counties in the United States that have active rigs, a record low, according to Rystad.

Oil production shut ins are mounting. Weekly data from the U.S. Energy Information Administration pegs U.S. oil production at 11.9 million barrels per day (Mbd) as of May 1, down 1.1 Mb/b in just a few weeks. But the losses are surely set to continue. A Reuters analysis says that the U.S. and Canada are on track to shut in 1.7 Mbd of supply by the end of June.

Globally, supply shut ins could reach as much as 17 Mbd in the second quarter, according to IHS Markit. “The Great Shut-In, a rapid and brutal adjustment of global oil supply to a lower level of demand is underway. All producing countries are subject to the same brutal market forces. Some will be impacted more than others,” Jim Burkhard, vice president and head of oil markets, IHS Markit, said in a statement. “But there is nowhere to hide.”

The latest announcements came from Continental Resources, which said on Monday that it was curtailing 70 percent of its oil production in May, after reporting a first quarter loss of $186 million. Last week, EOG Resources said it would cut oil production by a quarter, while also cancelling 40 percent of the new wells the company had planned to bring online this year. Houston-based Callon Petroleum said shut down all its fracking work in April and would only have one rig operational in May.

The financial carnage in the oil industry comes even as the Trump administration has attempted various policies aimed at propping up embattled drillers. But the number of bankruptcies in the U.S. oil patch is destined to rise.

Will the oil market rebound?
The prospect of the world running out of storage has receded somewhat, but only because of widespread shut ins. Oil executives are now hoping to survive until the market rebounds. But when will that happen?

Continental Resources seems to think better days are nearly here already. “We’re preserving the production capacity for what we believe will be an imminently better commodity price for us,” Continental’s CFO John Hart told analysts and investors on an earnings call.

In a bit of bravado, other oil executives voiced similar sentiments. Parsley Energy and Diamondback Energy both said in early May that they would consider getting back to drilling if oil merely rose to $30 per barrel.

Analysts warned against an attempt at restarting too soon. Investors “remain more cautious on demand and the sustainability of a rally, particularly in the near term given that oil prices are nearing levels where companies are indicating they could consider reversing some shut-in production,” Goldman Sachs wrote in a note. Translation: Oil prices have limited upside since the industry may begin bringing production back online too soon.

The reason this is important is because demand won’t rebound to anything close to “normal” in the near-term. “We anticipate that some changes in travel patterns, especially vis-a-vis aviation, will prove long-lasting, which means that it is emphatically not realistic to expect a return to 2019 demand levels until 2022 at the earliest,” Raymond James warned in a report on Monday.

The investment bank paints a rough picture of a 5 Mbd demand loss in 2021 related to the pandemic. There is no going back to “normal” on the supply side so long as demand is sharply down. A sizable portion of the 17 Mbd or so of supply shut ins may remain offline indefinitely.