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Texas searches for oil industry salvation

Record low oil prices are compelling the state to consider proration. But greater measures may be needed to stave off financial ruin

Economic conditions across the Texan oil patch are dire. Unemployment rates have skyrocketed in recent weeks, while the rig count is in freefall. Oil contracts plummeted into negative territory for the first time in US history on 20 April, scarcely believable when, just a few months prior, WTI topped $50/bl.

Fears of industry collapse across the shale patch have become so severe that a host of independent producers, headed by Parsley Energy and Pioneer Natural Resources, are pleading with Texas to enforce state-wide proration of output—much to the chagrin of larger operators such as ExxonMobil and the newly-enlarged Occidental.

“Producers think an orderly reduction in oil supply will protect the viability of independents and service providers,” says Hillary Cacanando, a research analyst at US bank Odeon Capital Group. “They think, if there is no cut, there will be 1mn jobs lost across the country.”

But without the backing of other producer states, any proration is unlikely to dent the global supply overhang. The US produces a total of around 13mn bl/d, with Texas pumping out 5mn bl/d. If the state’s oil and gas regulator, the Texas Railroad Commission (TRC), enforces a 20pc state-wide reduction in supply, as requested, this would be a drop in the ocean, especially when global demand is expected to be down by a much as 27mn bl/d in April.

Working together

The Texan state agency agreed that collaboration between states would be necessary before any cuts were considered. But even proration across states is unlikely to bring relief to WTI prices. Without further supportive action from suppliers elsewhere, including Opec+ countries, lowering US output simply by decree will still likely be insufficient to buoy prices. “Proration should be tied to other countries’ production,” said commissioner Ryan Sitton, during the agency’s 21 April hearing. “Another 4mn bl/d should be brought off the market by Opec+ to back up our 1mn bl/d.”

“This is a war on our industry by foreign adversaries” Wayne Christian, Texas Railroad Commission

Russia and Saudi Arabia, the two Opec+ heavyweights, are not the most obvious allies for the US oil industry. Both set about ramping up output after failed talks in early March with US shale clearly in their sights. “This is a war on our industry by foreign adversaries,” complained Wayne Christian, chairman of the TRC during the meeting.

The unprecedented impact of the Covid-19 pandemic on global energy demand has already forced the cartel to change its strategy, with the alliance ultimately agreeing to reduce output for May and June by 10mn bl/d after prices nosedived. Both Riyadh and Moscow realise the need to balance aspirations of grabbing market share at the expenses of US shale with shrunken government revenue streams in a sustained depressed price environment. Current conditions may be so ruinous that the group could yet consider some sort of compact with the US ahead of the next scheduled Opec+ meeting in June.

Crucial factor

Storage is the immediate pressing concern that could drive the US to consider its first mandated supply cuts in almost a century. US onshore production, of which the vast majority is shale—and hence the WTI benchmark which prices off a storage hub in the landlocked state of Oklahoma—is particularly susceptible to a lack of available storage options. This contrasts with Brent, the other global benchmark, which has far greater physical optionality as a seaborne Fob market—as well as its future contracts being able to settle financially rather than expiring into physical delivery.

“The oil storage shortage problem is real and the delayed reaction to it is the reason markets are in panic during recent days”, says Bjornar Tonhaugen, head of oil markets at consultancy Rystad Energy.

1mn bl/d – suggested Texas production cut

WTI futures contracts physically deliver at Cushing, OK. But readily accessible storage there is filling up rapidly, to the brink of capacity. “Our latest storage capacity models suggest we may run out of onshore storage either first week of May, or if we include all remaining storage with 100pc utilisation, the theoretical deadline would be postponed to the end of May,” says Tonhaugen.

If US storage reaches this tipping point then many companies will likely be forced to cut back production, regardless of whether any cuts have been mandated by the authorities.

Independents with little portfolio diversification have already been forced to reduce output in basins where the capacity of evacuation pipelines is maxed. Even larger-cap firms—with a wider range of production locations, and therefore greater reluctance to embrace mandated cuts at this point—will soon face scaling back if and when storage reaches capacity.

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