Could The Worst Be Over For America’s Oil Frackers?

Ten weeks into the Coronavirus crisis, and a month after crude oil prices dropped below zero, the price of West Texas Intermediate crude is now at $35. America’s oil producers have slashed output and cut $400 billion from capital spending budgets. The pace of drilling is down more than 80% from the peak of the Great American Oil Boom that saw output more than double in less than a decade. 

 

So where’s the evidence of green shoots?

 

To start, Americans are driving more. Corona-lockdowns had gutted gasoline consumption by mid-April. Now, according to Deutsche Bank numbers, we’re only driving 30% less than before. Likewise, worldwide petroleum demand appears to have bottomed out in May at 79 million barrels per day (bpd), according to Rystad, the energy consultancy, which sees June demand creeping up to 84 million bpd. Still a far cry from the 99.5 million rate at the end of 2019, but it’s progress.

 

Meanwhile, America’s oil drillers are helping to alleviate the oversupply by mothballing rigs with unprecedented urgency — the Baker Hughes BHI rig count is down nearly 500 this year, to 289. That’s helped knock 1.6 million bpd off of U.S. crude output in just two months. For comparison, during the last oil bust in 2015/16 it took 17 months for domestic volumes to drop by 1.1 million bpd.

 

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As the pace of U.S. curtailments has slowed; analysts at Cowen & Co. have become slightly more optimistic, now expecting a bottoming of U.S. drilling activity in the third quarter of 2020. A week ago they thought that wouldn’t come until 2021.

 

And yet, there’s still plenty reason to remain pessimistic on the U.S. oilpatch. Equity analysts have been dropping coverage of overly indebted companies; Cowen on Friday gave up on offshore drillers Valaris ($6 billion in debt against just $70 million in equity) and Noble ($3.8 billion in debt and $30 million equity), saying of the latter “a debt restructuring is a significant possibility.” Such bellwhethers as Chesapeake Energy CHK are living on borrowed time, with analyst Featherstone at Credit Suisse stating in a Friday report his expectation that CHK shares will slide from $13 to $1 or less. He also sees 67% downside potential for natural gas producers Range Resources RRC and Southwestern Energy SWN.

 

The pain has certainly not spared the biggest operators. Chevron CVX last week was the first of the supermajors to announce big layoffs — of about 6,000 people, or 10% of its global workforce. Even ExxonMobil XOM is strapped; projecting a free cash flow deficit of $2 billion this year, it will have to borrow in order to pay out $15 billion in dividends. Shares are down 40% in the past year.

 

And then there’s Occidental Petroleum, the big oil company in the direst of straits. Oxy OXY had already slashed its quarterly dividend from 79 cents per share to 11 cents, and on Friday said it was taking it all the way down to 1 cent per share (something CEO Vicki Hollub should have done in the first place). That will save an additional $360 million a year in cash, but it’s far from enough to address Oxy’s crippling debt load of more than $30 billion taken on to finance last year’s takeover of Anadarko Petroleum — including $12 billion in maturites coming due by the end of 2023. Oxy’s net debt amounts to 6.5 times Ebitda, nearly twice the average leverage of its large-cap peers. Even assuming several billion in forthcoming asset sales, Featherstone sees the company running out of liquidity before the end of 2022, with 40% downside in its “very expensive” stock to a target of $8 per share. At $13, the stock has already lost 75% in the past year.

 

This should all make OPEC happy. The cartel sees this crisis as the golden opportunity to knock America’s frackers out of business and regain lost market share — eventually. OPEC has instituted 10 million bpd of cuts in May and June in order to stabilize the market amid demand destruction. Analysts expect continued OPEC curtailments of 7.7 million bpd during the second half.

 

But there’s no way that OPEC is going to hold back further in order to make room for America’s frackers. According to Deutsche Bank numbers, OPEC’s share of the global oil market has slid from 42% a few years ago to 31% — its lowest in 20 years.

 

Recall that this oil crisis began even before the virus crisis, with the Saudi Arabia vying with Russia to swamp the world with oil in order to regain share. Before agreeing to emergency cuts, the Saudis in March launched an armada of tankers en route to the U.S. Gulf Coast. Last week 11 of the 16 Saudi tankers unloaded 23 million barrels here (according to Argus Media) drawing criticism from the likes of Sen. Ted Cruz, who criticized the Saudis for trying to further drive down oil prices and hurt American shale drillers. Cruz has floated the idea of an anti-dumping tariff on foreign oil.

 

Unfortunately, there’s plenty more where that came from; since February the amount of extra crude being stored in tankers at sea has trebled to 300 million barrels. Analyst Michael Hsueh at Deutsche Bank sees oil prices recovering to $45/bbl in 2021 as long as OPEC is able to maintain cooperation on export cuts. With all the excess production capacity offline around the world, even that looks like wishful thinking.