Piling the pressure on US LTO
The country’s production may struggle to return even to its pre-pandemic levels, while growing to new heights seems a distant prospect
The US light tight oil (LTO) industry has been on a heck of a ride over the past decade. Domestic crude production has more than doubled, reaching record levels and stealing substantial market share from Opec and its allies.
On the other hand, the competitive threat from rampant US supply has also triggered two oil price wars. And the economic fallout from the second of these and from the Covid-19 pandemic means it will take several years for US LTO production to match the record 9.15mn bl/d set in December 2019, before industry shut-ins and the widescale collapse in drilling activity (see Figures 1 and 2). At worst, US LTO output may have peaked.
A wall of cash from banks, private equity firms and retail equity investors propelled the US shale industry in the first half of the last decade and sustained it through the 2014-16 price war. But this flow of funds began to slow in late 2018 and has recently fallen off a cliff for a simple reason: the industry never made money.
Consultancy Deloitte estimates the US shale industry as a whole had negative cash flow of $300bn over the past decade-and-a-half, wrote down another $450bn in invested capital and has suffered more than 190 bankruptcies since 2010. Deloitte estimates that roughly 30pc of US shale drillers are “technically insolvent” with WTI at $35/bl.
Accentuating the capital crunch of the US shale industry, high-yield companies—the ones in greatest need of capital—saw their loan borrowing bases cut by an average of 23pc during their spring redeterminations, according to ratings agency S&P Global Ratings. US independents Chaparral Energy and Oasis Petroleum were especially hard hit, seeing their credit lines cut by 46pc and 44pc, respectively.
According to consultancy IHS Markit, $50/bl WTI will be needed to support growth in US LTO output—above shut-in volumes returning to market at lower prices. This should be no great surprise, as 650 active drilling rigs are needed merely to keep LTO production flat given high initial decline rates—assuming rig productivity is on par with the first quarter of this year (see Figure 2) and the same proportion of oil and gas directed rigs as in the past. If oil prices were to rise significantly above this level, and growth in US LTO output was to again take off, this year’s aborted price war would also likely resume.
Peak oil demand?
The financial and economic aftermath of the Covid-19 pandemic, combined with a new cold war between the US and China, will bring the timeline of peak oil demand forward, with global oil consumption possibly having already peaked at almost 101mn bl/d last year.
The sustainable rate of global economic growth is likely to be significantly slower in the future for two reasons: the rise of trading blocs under the new cold war; and a lack of fiscal and monetary firepower. The global economy grew at an average rate of about 3pc/yr during the original Cold War, from 1947 to 1991. This compares with 3.7pc/yr since 2001, when China joined the World Trade Organization (WTO) and economic globalisation took off in earnest.
In addition, since the 2007-09 global financial crisis, economic growth has been pushed up as a result of loose fiscal and monetary policies by the major powers, including the US and China, contributing to the current lack of policy firepower. The situation has been worsened by super-loose fiscal and monetary policies in recent months as governments seek to avoid pandemic-induced financial and economic collapse.
Global oil intensity has fallen by an average of roughly 2.5pc/yr since 2001 despite relatively modest efforts to move away from oil in the all-important transport sector. As a result, global economic growth will have to average above this rate at least to see growth in global oil demand.
At the same time, the base level of global oil demand may now be less than 101mn bl/d, with pandemic-induced behavioural shifts in business and commuter travel likely to permanently lower jet fuel and gasoline consumption.