The coronavirus pandemic is dramatically changing the world; the shock to the global economy cannot be understated. Hardly immune from the turbulent markets, a coronavirus-induced global recession has compounded the distress of oil companies well. The pandemic has led to a dip in demand for oil, and, after failed OPEC negotiations and the subsequent price war between Russia and Saudi Arabia, oil prices have plunged.
At the heart of the conflict between the two countries are U.S. shale oil producers, whose dramatic takeover of the oil market in recent years has become a source of uneasiness for the long-standing leaders of the energy industry.
Because the extraction of shale oil is expensive, however, low oil prices imply U.S. shale companies cannot operate profitably. The technology of hydraulic fracturing, used by U.S. shale companies, is more expensive than the conventional, vertical method of extraction.
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Vertical drilling vs horizontal drilling. (Credit: ValueTheMarkets)[/caption]
With this in mind, Moscow has flatly refused to reduce their production of oil. They are more than willing to strike a blow at America’s oil industry to prop up Russia’s position in the global energy markets.
Considering the sheer complexity of the situation, as well as the shale industry’s significance to American economic and foreign policy interests, Washington should help struggling shale oil producers. This time, there are reasons for both Democrats and Republicans to bail out the companies.
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Gas refinery.[/caption]
THE OIL PRICE WAR
The Saudi-Russian oil price war is not a war in a conventional sense of this word, but rather a situation in which both countries continuously reduce oil prices to achieve certain ends. In this case, Saudi Arabia wants Russia to agree to deeper cuts to oil production to boost global oil prices and ensure Saudi oil interests do not experience steep decline because of the pandemic.
Russia and Saudi Arabia are actively undermining America’s growing influence in the oil market. What’s worse, the U.S. oil industry is currently under financial distress, as access to credit tightens, and it becomes difficult to operate profitably given the COVID-19 global economic crunch.
As a result of the COVID-19 pandemic, global oil prices have tanked by about one third, and the plunge in oil prices has sent shockwaves around the world—the Dow Jones Industrial Average and the S&P 500 index fell by almost 8%. Remember that oil is the lifeblood of the modern economy; it fuels everything from vehicles and airplanes that transport lines that deliver goods around the world, to manufacturing plants and households.
The international oil cartel OPEC, or the Organization of Petroleum Exporting Countries, is a collection of market participants colluding with each other for higher profits or to gain a larger share of markets. They are led by Saudi Arabia. Russia is an external collaborator, which is where the “plus” sign in the OPEC+ acronym comes from; OPEC+ is an informal name for the cooperation between OPEC and Russia.
In the wake of the coronavirus pandemic, the organization made moves to cut the production of oil to offset the reduction in demand—thereby increasing their prices and profit.
As the economic situation worsened, however, Riyadh proposed even deeper cuts. But, on March 5th, during the OPEC+ meeting in Vienna, Russia’s minister of energy, Alexander Novak, told his Saudi Arabian counterpart Prince Abdulaziz bin Salman that Russia would not agree to further cuts in oil production. The reason? The U.S. shale industry.
The energy competition between the United States and Russia is not limited to the oil market—both countries have a high-stakes standoff in the gas sector as well.
For instance, the Trump administration has imposed sanctions on European and Russian companies to halt the construction of the Nord Stream 2, a pipeline that would, if completed, pump fifty-five billion cubic meters of natural gas from Siberian gas fields directly to Germany. Washington justified these measures on the grounds that Germany’s over-dependence on Russia for its energy needs would endanger Europe’s national security. Washington’s actions have delayed the completion of the pipeline for a year, if not longer.
So far, the United States has maintained supremacy in its energy feud with Russia. America has already become the world’s largest extractor of oil, a net exporter of the commodity for the first time in decades, and is on track to surpass Saudi Arabia as the world’s largest exporter of oil.
But recent events have dramatically changed things.
“The Kremlin has decided to sacrifice OPEC to stop U.S. shale producers and punish the U.S. for messing with Nord Stream 2,” Alexander Dynkin, president of the Institute of World Economy and International Relations in Moscow, a state-run think tank told the Los Angeles Times. Moscow believes that any further production reductions in prices would only prop up American shale oil producers and increase their share of the market. Igor Sechin, the CEO of Russia’s state-run oil company Rosneft reportedly told Russian President Vladimir Putin that low prices “are great because they will damage U.S. shale.”
After the breakdown of the deal, Saudi Arabia and its allies flooded the market with low-priced oil to drive out Russia; this is what launched the price war. In response, Russia ramped up its production as well. It seems as though the United States, Russia, and Saudi Arabia are all currently engaged in the high-stakes game of chicken—except with oil prices.
Russia and Saudi Arabia are actively undermining America’s growing influence in the oil market. What’s worse, the U.S. oil industry is currently under financial distress, as access to credit tightens, and it becomes difficult to operate profitably given the COVID-19 global economic crunch. While some companies have hedged against such risks, if such low prices persist for an extended time, many may go bankrupt.
There are many reasons—for both Republicans and Democrats—to ensure a bailout for the shale industry.
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Train yard.[/caption]
THE BIPARTISAN CASE FOR THE BAILOUT
Many Republicans (rightfully) oppose the bailout of private companies on the grounds that the government should not interfere in business so blatantly. Joseph Schumpeter once pointed out that certain things need to break for the system as a whole to evolve, the phenomenon he called creative destruction. Along similar lines, Nassim Taleb noted that a free-market economy should be antifragile, or benefitting from stressors. After all, crises eliminate the weakest companies, hence empowering those who are robust enough to withstand shocks, for it is the strongest companies who add the most value to the economy by innovating and improving people’s well-being.
Helping the failed is counterproductive, therefore, because it lets risks and weaknesses accumulate in the system, endangering its long-term viability.
Consolidation may result in stronger shale companies ... but it "would also weed out many companies that have been pursuing production growth at all costs despite being uneconomical. As a result, this oil price war may impair shale’s ability to grow as quickly in the future as it has in the past."
But today, oil prices are not determined by market forces; they are manipulated by the OPEC+ cartel. Government interference is necessary and justified, therefore, to balance the damage wrought by the cartel. The tactic currently used by both Saudi Arabia and Russia is called “dumping”—the artificial lowering of prices by producers, often to the detriment of the seller itself, to gain a larger share of the market and drive out weaker competitors—so-called “injure pricing.” This is not how free markets are supposed to function.
Indeed, if the U.S. government does not step in to protect its shale oil producers, the oil market in the United States may become even more concentrated. Several big companies—such as Chevron and ExxonMobil—are strong enough to withstand this kind of shock. At the same time, smaller producers are expected to face bankruptcies or will be bought by the bigger companies, reducing competition in the sector.
Consolidation may result in stronger shale companies, but, as Foreign Policy notes, it “would also weed out many companies that have been pursuing production growth at all costs despite being uneconomical. As a result, this oil price war may impair shale’s ability to grow as quickly in the future as it has in the past.”
For decades, the United States was actively involved in the Middle East, in part because the region has been a primary exporter of oil to the United States. This was what led to the so-called Carter doctrine, whereby Washington would use military force to protect its interests in the Middle East. Keeping the supply of oil safe and uninterrupted is the reason why there are so many American troops in Saudi Arabia and other Arab countries, as well as aircraft carrier groups in the Persian Gulf. Recall that the recent wars in Iraq, Afghanistan, Syria and Pakistan have cost the U.S. more than $6 trillion since 2001.
America’s growing oil industry in recent years, however, has powered an unprecedented geopolitical transition. America has become a petroleum powerhouse; it no longer needs the Middle East. The Economist even coined the term “Saudi America” to reflect these tectonic shifts in the energy market.
But with the U.S. shale oil industry currently in danger, this advantage may be lost. Saudi Arabian and Russian oil is much cheaper than American oil, and they have enough financial resources to withstand the adverse effects of low oil prices for a long time. U.S. shale producers, however, do not.
Democratic presidential hopefuls, including Bernie Sanders and Joe Biden, and President Donald Trump, have long-since declared the need to disentangle the United States from the Middle East, and end America’s “forever wars.” But geopolitical decoupling cannot be pursued without energy independence, which, in turn, cannot be attained when the U.S. shale industry is on the brink of destruction.
Last but not least, an oil price collapse would devastate the American economy, especially oil-rich states like Texas, New Mexico, North Dakota. Because the United States currently exports more oil than it imports, any benefits stemming from low gasoline prices for consumers will likely be offset by the harm to oil producers and workers. Furthermore, the low gasoline prices will have a little positive impact on people’s pockets when citizens are all sitting at home because of COVID-19.
The U.S. shale industry is essential to the economy; it drove ten percent of the total economic growth between 2010 and 2015. And both Democrats and Republicans are interested in saving the local economies and good-paying jobs.
Of course, Democrats may object to the bailout of the shale oil industry on the grounds that they cause carbon dioxide emissions to rise. While this may be true, even if the U.S. stops extracting shale oil, what recent activity in the energy market has shown us is that other countries will quickly fill the void left in the global oil market. This means that the net emission of greenhouse gases will not change—and may even rise—because these states likely do not have in place strong regulations on the activity of oil extractors as the United States does.
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Oil fields.[/caption]
THE HOPE IS NOT LOST
President Trump initially ordered the Department of Energy to purchase more oil from domestic producers for the Strategic Petroleum reserve stockpile, thereby propping up shale oil companies. But in the $2 trillion coronavirus relief package signed by President Trump, the $3 billion intended for this use was left out, with the Democratic Senate Minority Leader Chuck Schumer claiming, in an email distributed to senators, that the new version of the bill “eliminated [a] $3 billion bailout for big oil.”
The coronavirus pandemic has impeded the shale revolution. But sooner or later the recession will end, and shale oil companies will once again recover and bolster America’s energy independence, create new jobs, and redefine geopolitical order in the Middle East—provided, of course, that they survive the current crisis.
The Trump administration must act now to initiate separate legislation aimed at bailing out shale oil companies. The success of the shale oil industry is vital for U.S. national security and its economy.
Department of Energy spokesperson Shaylyn Hynes said in a statement that “Small to medium size American energy companies and their employees should be provided the same relief being provided to other parts of our economy, and the Secretary calls on Congress to work with the Administration to fund the President’s request as soon as possible… The American energy sector is a major driver of our nation’s economy and it is being significantly harmed by the impacts of COVID-19 and international market manipulation.”
Meanwhile, Domestic Energy Producers Alliance intends to file an “anti-dumping” complaint with the U.S. Department of Commerce. If the case is passed—which is highly likely—Washington will have a legal right to impose punitive tariffs on those responsible for the oil price collapse.
The hope for diplomatic resolution of the on-going price war is not lost. Everyone—the U.S., Saudi Arabia, and Russia—are interested in higher oil prices, and the current situation is a zero-sum game that every player wants to escape with minimum losses.
Nevertheless, we should not expect widespread bankruptcies in the U.S. shale oil sector soon. Consultants Rystad Energy claims that, “under the $30 WTI scenario, which is the one closest to the current price levels, oil production in the Lower 48 states would continue to grow towards July-August by around 200,000 to 300,000 bpd versus current output levels.” Only if the oil war prolongs will the industry be threatened. In this case, federal help will be needed.
Considering how tech giants like Microsoft, Google, and Amazon are becoming involved in the industry by empowering the process of drilling new wells with artificial intelligence and machine learning, it is expected that the industry is yet to experience even more success. As Barclays research report from January 2020 concludes, the industry has “at last seized on the promise of digital and is poised for a step-change in efficiency over the next five years.”
The coronavirus pandemic has impeded the shale revolution. But sooner or later the recession will end, and shale oil companies will once again recover and bolster America’s energy independence, create new jobs, and redefine geopolitical order in the Middle East—provided, of course, that they survive the current crisis.
